You currently own shares in Bentel Mutual Fund (BMF). Your broker callsand recommends buying shares in a small-capitalization fund managed byWolly Investment Group (WIG). Your broker says that this fund will providesignificant diversification benefits for your existing holdings. She gives youthe following statistics based on the performance of the two funds over thelast year.

Portfolio E(Return) Std. Dev.

Bentel Mutual Fund 20% 12%

Wolly Investment Grp. 14% 11%

a) Assume you can earn an average annual yield of 8% on a risk-freesecurity. Which of these funds would be the optimal fund to combinewith the risk-free security? Why? (6 Marks)

b) Using the fund you selected in part (a), how much portfolio weights in thefund and the risk-free security would be required to earn a target return of22%? Describe this position.

Answer rating: 100% (QA)

a To determine the optimal fund to combine with the riskfree security we need to consider the riskre... View the full answer