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You are constructing a risky portfolio for a client, to be comprised of both an equity fund and a bond fund. The probability distributions of the two funds are guven below. The correlation between the two funds is 0.10.
QUESTION 11
11.) For an investor with a risk-acersion score (A) of 4, identify the portfolio he woud rationally select.
a) what is the expected return of this portfolio?
b) what is the standard devistion of this portfolio?

Use the following information for questions 10 through 13 You are constructing a risky portfolio for a client, to be comprise
11) For an investor with a risk-aversion score (A) of 4, identify the portfolio he would rationally select. a) What is the ex
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Answer #1

Assuming the portfolio is equally weighted, i.e., Equity fund has 50% weight and Bond fund has 50% weight.

a. ErP = wAErA + wBErB

ErP = 0.5x0.12 + 0.5x0.08 = 10.0%

b. σP = (wA2σA2 + wB2 σB2 + 2wAwBσAσBρAB)1/2

σP = is the portfolio standard deviation;

wA = weight of asset A in the portfolio

wB = weight of asset B in the portfolio;

σA = standard deviation of asset A;

σB = standard deviation of asset B;

ρAB = correlation coefficient between returns on asset A and asset B

σP = (0.52 x 0.222 + 0.52 x 0.152 + 2x0.5x0.5x0.22x0.15x0.1)1/2 = 13.92%

Utility of portfolio (U) = E(p) – 0.5 x A x σ2

U = 0.1 - 0.5*4*0.13922

U = 6.12%

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