Question
You are a fund manager who considers investing in the following three mutual funds: a stock fund (S) with an expected return of 18% and
You are a fund manager who considers investing in the following three mutual funds: a stock fund (S) with an expected return of 18% and a return standard deviation of 25%, a long-term government bond fund (B) with an expected return of 9% and a return standard deviation of 12%, and a risk-free money market fund (F) with a rate of return of 5%. The return correlation between the two risky funds, S and B, is 0.25. Suppose your utility function is given by U=E(rC)-0.5AC 2 and your coefficient of risk aversion A is equal to 3. What are the weights on the two risky funds, S and B, and on the risk-free money market fund, F, consisting of the optimal complete portfolio (C)? What are the expected return and the standard deviation of the optimal complete portfolio? Are you borrowing or lending at the risk-free rate?
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