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A pension fund manager is considering three mutual funds. The first is a stock

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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


risky portfolio.


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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