Determine the investors optimal portfolio allocation

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An investor seeks to create a portfolio from three types of securities: Treasury Bills (T), Corporate Paper (C), and Junk Bonds (J). The table lists the expected rates of return for the asset types and their average risk (on a 1-5 scale, where ‘5' denotes maximum risk). The investor seeks portfolio allocations (T + C + J = 1) that will maximize the expected return on her portfolio, while maintaining an overall risk of no more than ‘3'. Security Return (%) Risk Treasury Bills 2.5 2.0 Corporate Papers 5.0 2.5 Junk Bonds 8.0 5.0

(a) Formulate the investor's linear programming problem.

(b) Determine the investor's optimal portfolio allocation and the maximum expected return on her portfolio. (To determine the optimal portfolio allocation, you will need to use your constraints from part (a). To find the maximum expected return on her portfolio, use the objective function equation from part (a) and the optimal asset allocation.) (Hint: the two assets in the optimal portfolio are corporate papers and junk bonds)

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