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Problem 4. The risk-free government securities provide the rate of return of 3%. Statistics for three stocks, A, B, and C, are shown in the
Problem 4. The risk-free government securities provide the rate of return of 3%. Statistics for three stocks, A, B, and C, are shown in the table below. Correlation Stock Mean return Std. deviation A A 10% 31% 1.00 0.90 0.60 B 12% 36% 0.90 1.00 0.30 9% 24% 0.60 0.30 1.00 Suppose that your attitude toward risk is represented by the mean-variance utility function (where mean return and standard deviation are measured in percentages) 1 U(T) = E[r] - A Var[r), 200 and your coefficient of risk aversion A = 2. Your current portfolio consists of $700,000 invested in stock A and $300,000 invested in the government securities. a) Compute the mean return, standard deviation, and Sharpe ratio of your port- folio. You consider selling government securities and investing the proceeds in either stock B or stock C. b) Compute the mean return, standard deviation, and Sharpe ratio of the portfolio of stocks A and B. c) Compute the mean return, standard deviation, and Sharpe ratio of the portfolio of stocks A and C. d) Decide whether you should transfer money from the government securities to either stock B or C
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