Problem Set- Asset Allocation 2A

Assume the following capital market expectations. Answer the three questions below:

	E(r)	Std. Deviation
Stocks	0.14	0.245
Bonds	0.09	0.148
Cash	0.06	0.000
Correlation (rs, rb)	-0.2378

1. Find:

1. The most efficient way (lowest risk way) to achieve an E(r) of 9% from a portfolio of cash, stocks and bonds.

First locate O* (the optimal risky portfolio) by solving for:

W_s^* = ________, W_b^* = ________, E(r_p)^* = ________, _p^* = ________

Now explore what proportion would need to be invested in O* as well as in risk-free assets.

E(r_c) = 9.00% = 6% + y (E(r_p)^* - 6%

y = proportion in O_p^*= ________

1-y = proportion in cash = ________

2. The standard deviation of the portfolio.

_c^* = ________

3. The proportion invested in the three assets of cash, stocks and bonds.

Cash (1-y) = ________

Stocks (W_s^* )(y) = ________

Bonds (W_b ^*)(y) = ________