Problem 2

You are the financial adviser to three individuals, a Young person with high risk tolerance, a Middle

aged person with medium risk tolerance and an old person with low risk tolerance. Here are the current

conditions:

Risk free asset earning 4% per year

Risky asset, (or market portfolio), with expected return of 13% per year and standard deviation of 20%.

Using the mutual fund theorem (Separation theorem), see my lecture notes and the video for chapter 5:

a. Construct an appropriate portfolio for your young client and estimate the expected return and standard deviation of your young client for the coming year.

Young client's recommended asset allocation is 90 % Risky assets and 10 % Risk Free asset.

b. Construct an appropriate portfolio for your middle aged client and estimate the expected return and standard deviation of your middle aged client.

Middle Aged client's recommended asset allocation is60 % Risky assets and 40 % Risk Free asset.

c. Construct an appropriate portfolio for your old client and estimate the expected return and standard deviation of your old client.

Old Client's recommended asset allocation is45 % Risky assets and 55 % Risk Free asset.

d. If your middle aged client requires a portfolio with a standard deviation of 12%, what is its expected rate of return?