Question

2. (Understanding optimal portfolio choice) Consider two risky assets, the expected return of asset one is μ-0.1, the expected return of asset two is μ2-0.15, the risk or standard deviation of asset one is σ1-0.1, the risk or standard deviation of asset two is σ2-02. The two assets also happen to have zero correlation. An investor plans to build a portfolio by investing w of his investment to asset one and the rest of his investment to asset two. Calculate the expected return of portfolio that mixes 60% of asset one and 40% of asset two. Also calculate the risk or standard deviation of this a. portfolio. How does the risk compare to asset one itself (i.e. building a portfolio with 100% asset one)? What about the return? What do you say about these two portfolio choices? Is asset one on the efficient frontier of portfolios? Now consider another risk-free asset with return μf-0.02. With this risk- free asset, one could find that the tangent portfolio of risky asset one and two mixes 71% of asset one and 29% of asset two. Now, complete the following capital market line by filling a calculated slope number for that line. b.

Answer 1

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