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 sure rate of 5.5%. The probability distributions of th risky funds are The following data apply to Problems 8-12. Standard Deviation 32% 23 Expected Return 15% Stock fund (S Bond fund (B) The correlation between the fund returns is.15 8. Tabulate and draw the investment opportunity set of the two risky funds. Use invest- ment proportions for the stock fund of 0% to 100% in increments of 20%, what expected return and standard deviation does your graph show for the minimum-variance portfolio? (LO 6-2) 9. Draw a tangent from the risk-free rate to the opportunity set. What does your graph show for the expected return and standard deviation of the optimal risky portfolio? LO 6-3) 10. What is the Sharpe ratio of the best feasible CAL? (LO 6-3) 11. Suppose now, that your portfolio must yield an expected return of 12% and be efficient that is, on the best feasible CAL. (LO 6-4) a. What is the standard deviation of your portfolio? b. What is the proportion invested in the T-bill fund and each of the two risky funds? 12. If you were to use only the two risky funds and still require an expected return of 12% what would be the investment proportions of your portfolio? Compare its standard deviation to that of the optimal portfolio in the previous problem. What do you con- clude? (L0 6-4) 3. Stocks offer an expected rate of return of 10% with a standard deviation of 20%, and gold offers an expected return of 5% with a standard deviation of 25%. (LO 6-3) a. In light of the apparent inferiority of gold to stocks with respect to both mean return and volatility, would anyone hold gold? If so, demonstrate graphically why one would do so b. How would you answer (a) if the correlation coefficient between gold and stocks were 1? Draw a graph illustrating why one would or would not hold gold. Could these expected returns, standard deviations, and correlation represent an equilibrium for the security market? 14. Suppose that many stocks are traded in the market and that it is possible to borrow at the risk-free rate, r The characteristics of two of the stocks are as follows: Stock Expected Return Standard Deviation 8% 40% 13 60 Correlation =-1 Could the equilibrium ,r be greater than i 0%? (Hint: Can a particular stock portfolio be substituted for the risk-free asset?) (LO 6-3)

Answer 1

Answer 8)

Please see attached picture. There are 2 pictures for this answer.

39, 50 S 99 29-110、y

2. 2. anma 9.00% o.20 19 48 60 40/ 25/ 0/ 18&2 91-24 6s、J, 100 IS 32.00 A-py

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Answer 9)

Draw a line from risk free rate (5.5%) tangential to this graph in picture. You can do this by suing Solver in excel.

This will give you

Expected return = 12.72%

Std Deviation = 21.68%

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Answer 10)

Risk Free rate = 5.5%

Risk Premium = Return of portfolio - risk free = 12.72% - 5.5% = 7.22%

Sharpe Ratio = Risk Premium / Std Dev of portfolio

=0.33302

Hope answers are clear