Question

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 sure rate of 4.8%. The probability distributions of the risky funds are:   

	Expected Return		Standard Deviation
Stock fund (S)	18	%	38	%
Bond fund (B)	9	%	32	%

The correlation between the fund returns is .1313.
Suppose now that your portfolio must yield an expected return of 15% and be efficient, that is, on the best feasible CAL.

a. What is the standard deviation of your portfolio? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Str Dev = ANS. 28.50

b-1. What is the proportion invested in the T-bill fund? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Proportion invested in the T-Bill fund: ANS. 8%

b-2. What is the proportion invested in each of the two risky funds? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Proportion invested in stocks? unsure

Proportion invested in bonds? unsure

A pension fund monager 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 theat yields a sure rate of 4.8 % . The probability distributions of the risky funds are: Expected Return 18 Standard Deviation Stock fund (S) Bond fund (B) 38 32% The correlation between the fund returns is 1313. Suppose now that your portfolio must yield an expected return of 15% and be efficient, thet is, on the best feasible CAL a. What is the standerd devietion of your portfolio? (Do not round Intermediate calculations. Round your answer to 2 decimal places.) Answer is complete and correct. Standard 28.50 daviation b-1. What is the proportion invested in the T-bill fund? (Do not round Intermedlate calculations. Round your answer to 2 declmal places.) Answer is complete and correct Proportion invested in the T-bill fund 8.00 b-2 What is the proportion invested in each of the two risky funds? (Do not round intermediate calculations. Round your answers to 2 decimal places.) Answer is complete but not entirely correct. Proportlon Invested 79.29 % Stocks 27.00 % Bands

Answer 1

To find the fraction of wealth to invest in Stock fund that will result in the risky portfolio with maximum Sharpe ratio
the following formula to determine the weight of Stock fund in risky portfolio should be used
w(*d)= ((E[Rd]-Rf)*Var(Re)-(E[Re]-Rf)*Cov(Re,Rd))/((E[Rd]-Rf)*Var(Re)+(E[Re]-Rf)*Var(Rd)-(E[Rd]+E[Re]-2*Rf)*Cov(Re,Rd)
							Where
						Stock fund	E[R(d)]=	18.00%
Bond fund	E[R(e)]=	9.00%
Stock fund	Stdev[R(d)]=	38.00%
Bond fund	Stdev[R(e)]=	32.00%
	Var[R(d)]=	0.14440
	Var[R(e)]=	0.10240
T bill	Rf=	4.80%
Correl	Corr(Re,Rd)=	0.1313
Covar	Cov(Re,Rd)=	0.0160
Stock fund	Therefore W(*d)=	0.7645
Bond fund	W(*e)=(1-W(*d))=	0.2355
	Expected return of risky portfolio=	15.88%
	Risky portfolio std dev (answer Risky portfolio std dev)=	30.96%
Where
Var = std dev^2
Covariance = Correlation* Std dev (r)*Std dev (d)
Expected return of the risky portfolio = E[R(d)]*W(*d)+E[R(e)]*W(*e)
Risky portfolio standard deviation =( w2A*σ2(RA)+w2B*σ2(RB)+2*(wA)*(wB)*Cor(RA,RB)*σ(RA)*σ(RB))^0.5
Desired return = tbill return*proportion invested in tbill+risky portfolio return *proportion invested in risky portfolio
= tbill return*proportion invested in tbill+risky portfolio return *(1-proportion invested in tbill)
0.15=0.048*Proportion invested in Tbill+0.1588*(1-Proportion invested in Tbill)
Proportion invested in Tbill (answer b-1) = (0.1588-0.15)/(0.1588-0.048)
=0.0794 (7.94%)
proportion invested in risky portfolio = 1-proportion invested in tbill
=0.9206 (92.06%)
Proportion invested in Bond fund (answer proportion invested in Bond fund) =proportion invested in risky portfolio *weight of Bond fund
=0.2168 (21.68%)
Proportion invested in Stock fund (answer b-2) =proportion invested in risky portfolio *weight of Stock fund
=0.7038 (70.38%)
std dev of portfolio (answer a) = std of risky portfolio*proportion invested in risky portfolio
0.9206*0.3096=28.5%