Question
There are three assets available to investors: 1) a stock fund with an expected return of 22% and a return standard deviation of 28%; 2)
There are three assets available to investors: 1) a stock fund with an expected return of 22% and a return standard deviation of 28%; 2) a bond fund with an expected return of 10% and a return standard deviation of 19%; and 3) a risk-free asset with a return of 1%. The correlation between the stock funds return and the bond funds return is -0.1. Mary is a risk-averse investor. Answer the following questions:
a. If Mary invests 5% of her portfolio wealth in the stock fund and 95% in the bond fund (She invests nothing in the risk-free asset), what is the expected return and standard deviation of her portfolio? [1 pt]
b. If Mary invests 100% of her portfolio wealth in the bond fund, what is the expected return and standard deviation of her portfolio? [0.5 pt]
c. Which portfolio between a) and b) would Mary prefer? Explain your answer. [0.5 pt]
d. Suppose Mary has to pick only one of the funds (the stock fund or the bond fund) to hold with the risk-free asset, which fund will she pick? Explain your answer. [2 pt]
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