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Sketch the set of portfolios composed of debt

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Reference no: EM13199623

An investor is uncertain about how much to invest in two risky assets. The first asset (equity) yields an expected return of 12% and has a standard deviation equal to 8%. The second asset (debt) yields an expected return of 6% and has a standard deviation of 5%. The correlation coefficient between the returns is -0.1.

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

Portfolio

Percentage in equity

Percentage in debt

1

75

25

2

50

50

3

25

75

Portfolio

% in debt

% in eq

ExRet

Var

SD

3

0.75

0.25

0.075

0.001731

0.041608

2

0.5

0.5

0.09

0.002125

0.046098

1

0.25

0.75

0.105

0.003681

0.060673
  1. Sketch the set of portfolios composed of debt and equity in the mean-standard deviation space and identify portfolios 1, 2 and 3.
  2. Would a rational risk-averse investor ever choose a portfolio entirely composed of debt? Would a rational risk-averse investor ever choose a portfolio entirely composed of equity?

Reference no: EM13199623

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