Question 1: A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a sure rate of 5.5%. The probability distributions of the risky funds are:

Stock Fund (S) E(Rs)=15% StdDev(s)=32%

Bond Fund (B) E(Rb)= 9% StdDev(b)=23%

The correlation between the fund returns is .15.

1. Tabulate and draw the investment opportunity set of the two risky funds. Use investment proportions for the stock fund of 0% to 100% in increments of 20%. What expected return and standard deviation does your graph show for the minimum-variance portfolio?

2. What is the reward-to-volatility ratio of the best feasible CAL?

3. Suppose now that your portfolio must yield an expected return of 12% and be efficient, that is, on the best feasible CAL.

a. What is the standard deviation of your portfolio?

b. What is the proportion invested in the T-bill fund and each of the two risky funds

4. If you were to use only the two risky funds and still require an expected return of 12%, what would be the investment proportions of your portfolio? Compare its standard deviation to that of the optimal portfolio in the previous problem. What do you conclude?