You consider investing in two mutual funds with the following parameters:

	Fund 1	Fund 2
Beta	0.8	1.2
Standard Deviation	20%	32%

The funds are valued in a market where investors can borrow and lend, using T-bills, at the risk free rate of 5% and require a risk premium above this risk free rate of 8% for holding the market portfolio.

Suppose you can borrow and lend at the risk free rate of interest. Which of the two funds do you prefer?

What is the lowest risk portfolio that gives you an expected return of 14.6%? What is its standard deviation? Construct this portfolio using one of the funds and T-bills.

Suppose you can invest at the risk free rate of 5% but you can only borrow at the higher rate of 7%. What is the lowest risk portfolio with an expected return of 14.6% now?