A pension fund manager is considering three mutual funds. The first is a stock
fund (S) (with expected return 20% and standard deviation 30%), the second is a long-
term government and corporate bond fund (B) (with expected return 12% and standard
deviation 15%), and the third is a T-bill money market fund (with expected return 8%).
The correlation between the stock fund (S) and the bond fund (B) is 1.0.
1. With careful estimation and calculation, the manager found that the optimal pro-
portions of each asset in the optimal risky portfolio are as follows:
wS = 0.4516 and wB = 0.5484. Solve for the expected return and standard deviation of the optimal
2. Suppose now the best feasible CAL available to the investor has a slope coefficient
of 0.40. If you require that your portfolio on this best feasible CAL yield an expected
return of 14%, what is the standard deviation of your portfolio?
3. What is the proportion invested in the T-bill fund and each of the two risky funds
to achieve an expected return of 14%? (use information from part 1 and part 2.)
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