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Compute the expected return and standard deviation

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Reference no: EM13199631

An investor is uncertain about how much to invest in two risky assets. The first asset (equity) yields an expected return of 10% and has a standard deviation equal to 8%. The second asset (debt) yields an expected return of 5% and has a standard deviation of 7%. The correlation coefficient between the returns is 0.1.

a. Compute the expected return and standard deviation of the following portfolios:

 

Portfolio

Percentage in equity

Percentage in debt

 

1

90

10

 

2

50

50

 

3

10

90

Equity

Debt


 

R

0.1

0.05


 

SD

0.08

0.07


 

Var

0.0064

0.0049


 






 

Portfolio

% in equity

% in debt

Expected R

Var

SD

 

1

0.9

0.1

0.095

0.005

0.073

 

2

0.5

0.5

0.075

0.003

0.056

 

3

0.1

0.9

0.055

0.004

0.064

 











b. In the mean-standard deviation space, sketch the set of portfolios composed of debt and equity and identify portfolios 1, 2, and 3 on your graph.

c. Would a rational risk-averse investor ever choose portfolio 3? Would a rational risk-averse investor ever choose portfolio 1?

Reference no: EM13199631

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