Question

Check my work Problem 7-23 10 points Skipped Greta, an elderly investor, has a degree of risk aversion of A=4 when applied to return on wealth over a one-year horizon. She is pondering two portfolios, the S&P 500 and a hedge fund, as well as a number of 1-year strategies. (All rates are annual and continuously compounded.) The S&P 500 risk premium is estimated at 9% per year, with a SD of 18%. The hedge fund risk premium is estimated at 5% with a SD of 25%. The returns on both of these portfolios in any particular year are uncorrelated with its own returns in other years. They are also uncorrelated with the returns of the other portfolio in other years. The hedge fund claims the correlation coefficient between the annual returns on the S&P 500 and the hedge fund in the same year is zero, but Greta is not fully convinced by this claim. eBook a-1. Assuming the correlation between the annual returns on the two portfolios is indeed zero, what would be the optimal asset allocation? (Do not round intermediate calculations. Enter your answers as decimals rounded to 4 places.) Print a References S&P Hedge a-2. What is the expected risk premium on the portfolio? (Do not round intermediate calculations. Enter your answers as decimals rounded to 4 places.) Expected risk premium %

Answer 1

At optimal portfolio, the risk taken will be minimum.

Hence setting this condition, we use the solver to find the efficient allocation.

a.

_ Clear Solver Parameters V A HI →IE I X À From Access [From Web From Other From Text Sources Get External Data Existing Connections Connections E Properties Refresh All - L Edit Links Connections Nó Sor Set Objective: $C$5 C5 : X V fx To: ОMax O Min O Value Of: By Changing Variable Cells: $D$3:$D$4 E F Subject to the Constraints: Add 2 A B C D 1 A 4 Risk Premium SD Weights 3 S&P 500 9% 18% 65.8588% 4 Hedge Fund 5% 25% 34.1412% Portfolio 14.6076% 0 Change Delete Reset All Load/Save Make Unconstrained Variables Non-Negative Select a Solving Method: GRG Nonlinear Options Solving Method Select the GRG Nonlinear engine for Solver Problems that are smooth nonlinear. Select the LP Simplex engine for linear Solver Problems, and select the Evolutionary engine for Solver problems that are non-smooth. Help Solve Close

b.

B5 x V fix =SUMPRODUCT(B3:B4,D3:04) A 1 A 2. 3 S&P 500 4 Hedge Fund 5 Portfolio Risk Premium SD Weights 0.09 0.18 0.658587984812219 0.05 0.25 |=1-D3 =SUMPRODUCT(B3:B4,D3:D4=SQRT((D3*C3)^2+(CO