Question

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a rate of 7%. The probability distribution of the risky funds is as follows: Expected Return Standard Deviation Stock fund (S) 18 % 35 % Bond fund (B) 15 20 The correlation between the fund returns is 0.12. What is the Sharpe ratio of the best feasible CAL? sharpe ratio=

Answer 1

We use MS Excel and the solver addin to find the optimal weights of the portfolio.

Then Sharpe ratio is given by (R-Rf)/Std Dev (portfolio)

Exp ret Std dev Cor(1,2) 0.12 Stock Bond Riskfree 0.18 0.15 0.07 0.35 0.20 Covariance matrix 0.1225 0.0084 0.0084 0.0400 Optimal portfolio Stock Bond Exp ret Std dev Sharpe ratio 0.296 0.704 0.159 0.185 0.482