9/28/2017 Assignment Print View

Score: 40/40 Points 100 %

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9/28/2017 Assignment Print View

1. Award: 10 out of 10.00 points

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-
term government and corporate bond fund, and the third is a T-bill money market fund that yields a rate of
8%. The probability distribution of the risky funds is as follows:

Expected Return Standard Deviation
Stock fund (S) 18% 35%
Bond fund (B) 15 20

The correlation between the fund returns is .12.

What are the investment proportions in the minimum-variance portfolio of the two risky funds, and what is
the expected value and standard deviation of its rate of return? (Do not round intermediate calculations
and round your final answers to 2 decimal places. Omit the "%" sign in your response.)

Minimum-variance portfolio
Portfolio invested in the stock 21.68 %
Portfolio invested in the bond 78.31 %
Expected return 15.66 %
Standard deviation 18.20 %

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-
term government and corporate bond fund, and the third is a T-bill money market fund that yields a rate of
8%. The probability distribution of the risky funds is as follows:

Expected Return Standard Deviation
Stock fund (S) 18% 35%
Bond fund (B) 15 20

The correlation between the fund returns is .12.

What are the investment proportions in the minimum-variance portfolio of the two risky funds, and what is
the expected value and standard deviation of its rate of return? (Do not round intermediate calculations
and round your final answers to 2 decimal places. Omit the "%" sign in your response.)

Minimum-variance portfolio
Portfolio invested in the stock 21.69 1% %
Portfolio invested in the bond 78.31 1% %
Expected return 15.65 1% %
Standard deviation 18.21 1% %

Explanation:

The parameters of the opportunity set are:

E(rS) = 18%, E(rB) = 15%, S = 35%, B = 20%, = .12

From the standard deviations and the correlation coefficient we generate the covariance matrix [note that
Cov(rS, rB) = SB]:

Bonds Stocks
Bonds 400 84.00

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9/28/2017 Assignment Print View
Stocks 84.00 1,225

The minimum-variance portfolio is computed as follows:

B2 Cov(rS,rB) 400 84.00

WMin (S) = = = .2169
S2
+ B2
2Cov(rS,rB) 1,225+400(2 84.00)
wMin(B) = 1 .2169 = .7831

The minimum-variance portfolio mean and standard deviation are:

E(rMin) = (.2169 .18) + (.7831 .15) = .1565 = 15.65%

Min = [wS2S2 + wB2B2 + 2wSwB Cov(rS,rB)]1/2

= [(.21692 1,225) + (.78312 400) + (2 .2169 .7831 84.00)]1/2

= 18.21%

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9/28/2017 Assignment Print View

2. Award: 10 out of 10.00 points

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-
term government and corporate bond fund, and the third is a T-bill money market fund that yields a rate of
7%. The probability distribution of the risky funds is as follows:

Expected Return Standard Deviation

Stock fund (S) 18% 35%
Bond fund (B) 15 20

The correlation between the fund returns is .12.

What is the reward-to-volatility ratio of the best feasible CAL? (Round your final answer to 4 decimal
places.)

Reward-to-volatility ratio .4818

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-
term government and corporate bond fund, and the third is a T-bill money market fund that yields a rate of
7%. The probability distribution of the risky funds is as follows:

Expected Return Standard Deviation

Stock fund (S) 18% 35%
Bond fund (B) 15 20

The correlation between the fund returns is .12.

What is the reward-to-volatility ratio of the best feasible CAL? (Round your final answer to 4 decimal
places.)

.4817 0.001
Reward-to-volatility ratio

Explanation:

The proportion of the optimal risky portfolio invested in the stock fund is given by:

[E(rS) rf] B2 [E(rB) rf] Cov(rS,rB)

ws =
[E(rS) rf] B2 + [E(rB) rf] S2 [E(rS) rf + E(rB) rf] Cov(rS,rB)

[(.18 .07) 400] [(.15 .07) 84.00]

= = .2958
[(.18 .07) 400] + [(.15 .07) 1,225] [(.18 .07 + .15 .07) 84.00]

wB = 1 .2958 = .7042

The mean and standard deviation of the optimal risky portfolio are:
E(rP) = (.2958 .18) + (.7042 .15) = .1589
= 15.89%
p = [(.29582 1,225) + (.70422 400) + (2 .2958 .7042 84.00)]1/2
= 18.45%

The reward-to-volatility ratio of the optimal CAL is:

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9/28/2017 Assignment Print View

E(rp) rf .1589 .07

= = .4817
p .1845

3. Award: 10 out of 10.00 points

Suppose you have a project that has a .4 chance of tripling your investment in a year and a .6 chance of
doubling your investment in a year. What is the standard deviation of the rate of return on this investment?
(Do not round your intermediate calculations. Round your answer to 2 decimal places. Omit the "%"
sign in your response.)

Standard deviation 48.99 %

Suppose you have a project that has a .4 chance of tripling your investment in a year and a .6 chance of
doubling your investment in a year. What is the standard deviation of the rate of return on this investment?
(Do not round your intermediate calculations. Round your answer to 2 decimal places. Omit the "%"
sign in your response.)

Standard deviation 48.99 1% %

Explanation:

The probability distribution is:

Probability Rate of Return

.4 200%
.6 100%

Mean = [.4 200%] + [.6 (100%)] = 140%

Variance = [.4 (200 140)2] + [.6 (100 140)2] = 2,400
Standard deviation = 2,4001/2 = 48.99%

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9/28/2017 Assignment Print View

4. Award: 10 out of 10.00 points

Suppose that you have $1 million and the following two opportunities from which to construct a portfolio:

a. Risk-free asset earning 6% per year.
b. Risky asset with expected return of 32% per year and standard deviation of 39%.

If you construct a portfolio with a standard deviation of 33%, what is its expected rate of return? (Do not
round your intermediate calculations. Round your answer to 2 decimal places. Omit the "%" sign in
your response.)

Expected return on portfolio 27.99 %

Suppose that you have $1 million and the following two opportunities from which to construct a portfolio:

a. Risk-free asset earning 6% per year.
b. Risky asset with expected return of 32% per year and standard deviation of 39%.

If you construct a portfolio with a standard deviation of 33%, what is its expected rate of return? (Do not
round your intermediate calculations. Round your answer to 2 decimal places. Omit the "%" sign in
your response.)

Expected return on portfolio 28.00 1% %

Explanation:

E(rc) = rf + E(rp) r(f) C

P

P = 33 = y = 39 y => y = 0.8462
E(rP) = 6 + 0.8462(32 6) = 28.00%

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