3330 PS5 (1) - c. Draw the investment opportunity set given...

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Cornell University Fall 2010 Economics 3330: Problem Set 5 Due 10/14/10 There are three assets: a stock fund, a bond fund, and a risk-free T-bill money market fund that yields a sure return of 5.5%. The stock fund has an expected return of 15% with standard deviation of 32% and the bond fund has an expected return of 9% with a standard deviation of 23%. The correlation between the funds is 0.15. a. What are the investment proportions in the minimum variance portfolio of the two risky funds, and what is the expected value and standard deviation of its rate of return? b. Create a table of the investment returns of a risky portfolio as the weight on the stock fund is varied from 0 to 100% in increments of 10% with the rest of the portfolio in the bond fund. In the table, include the portfolio expected return, standard deviation, and Sharpe ratio.
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Unformatted text preview: c. Draw the investment opportunity set given the data you generated in part (a). d. 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? Is your graph consistent with the minimum variance portfolio found above? e. What is the Sharpe ratio of the CAL? f. Suppose now that your portfolio must yield an expected return of 12% and be efficient, that is, on the CAL. What is the standard deviation of your portfolio? What is the allocation in each of the three assets? g. If you were to use only the two risky funds and still require an expected return of 12%, what would be the proportions of the two? Compare the standard deviation of this portfolio with the one in (f)....
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