Question

You are trying to build the best possible risky portfolio for your investment clients. You have two risky assets available to you: A risky stock with an expected return of 0.279 and a standard deviation of 0.51, and a risky bond with an expected return of 0.066, and a standard deviation of 0.740. If these two assets have a coefficient of correlation of 0.06, what proportion of the money you invest in risky assets should you put in the stock? An answer of 0 means invest no money in the stock, an answer of 1 means put all of your money in the stock.

Answer 1

You should invest the entire money in Risky Stock. That is 100% or 1 proportion.

The Risky Bond has a lower rate of return and a higher risk (standard deviation) than the Risky Stock. Hence investing any small amount in Risky Bond will reduce the overall return of the portfolio and increase risk.