Question
Suppose that you are allocating your investment capitals between risk free asset and risky asset. The expected returns of risk free and risky assets are
Suppose that you are allocating your investment capitals between risk free asset and risky asset. The expected returns of risk free and risky assets are 4% and 9%, respectively. The standard deviation of the risky asset is 20%. Your utility level can be described by the utility function, U(E(r),(r))=E(r)0.5A2(r). (6 points)
1) Explain how to find the complete portfolio under your preference (or utility function). Mention the relation between the capital allocation line and indifference curve. What is the Sharpe ratio of the risky asset?
2) Assume that your risk aversion is four (i.e., A = 2). What percentage of your capital is allocated to the risky asset? If your risk aversion is one (A = 1), how does your complete portfolio change?
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