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Assuming the CAPM holds. Consider a portfolio comprised of two risky assets. The expected return and standard deviation of the return on asset 1 are 1% and 6% respectively. The expected return and standard deviation of the return on asset 2 are 4% and 4% respectively. The correlation between the return on asset 1 and the return on asset 2 is -0.2.
a. What percentage should one invest in asset 1 to reduce portfolio risk to a global minimum? What is the expected return and standard deviation of the return on the global minimum risk portfolio?
b. Plot a table showing the expected return and standard deviation of the return on the portfolio for weights on asset 1 equal to -0.2, 0, 0.2, 0.4, 0.6, 0.8, 1.0 and 1.2.
c. Plot the minimum variance frontier.
d. If an investor puts 80% of the portfolio in asset 1, is the investor choosing a portfolio on the efficient frontier? Give the intuition for your answer.
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