Question #6: Asset Allocation and Leverage [24 Points] Suppose an investor has a choice between two assets: a risky asset and a risk-free asset. Investment Standard Deviation (6) Portfolio Weight Expected Return [E(r)] Risky Asset 9.70% 12.6% Risk-Free 3.2% 0 1-y (a) Calculate the expected return and standard deviation of the overall portfolio---a portfolio consisting of a mixture of the risky asset and risk-free asset. (Hint: Your answers will be expressed as a function of y] [6 Points] (b) Suppose that the investor chooses a portfolio weight of y = 1.2. What does it mean that y> 1? [2 Points) (c) Find the expected return and standard deviation of the overall portfolio is the investor has chosen a weight of y = 1.2. [Assume that the borrowing rate is equal to the risk-free rate] [5 Points] (d) Plot and label the following investment scenarios to derive the CAL: Scenario #1: y = 0 (Point A) Scenario #2: y = 1 (Point B) Scenario #3: y = 1.2 (Point C) What is the slope of the CAL? [7 Points] If y = 0, E(rc) = 0.032 and Op= 0 If y = 1, E(re) = 0.097 and op= 0.1260 If y = 1.2, E(rc) = 0.11 and Op= 0.1512 (e) What does the price of risk (A) measure? What would happen to y (the proportion invested in risky assets) should A increase? Explain your answer. [4 Points]