You invest your retirement money in a 401(k) plan offered by your employer. Until 2019, the plan offered you 5 risky assets to invest in; you could choose any portfolio that mixes those 5 risky assets, including short positions. Furthermore, your 401(k) allowed you to invest in Treasury Bills, so you had access to 6 assets in total. This year, your 401(k) plan has deducted 1 risky asset, shrinking its available risky assets to 4. You can also still invest in treasury Bills.

a. What happens to the Sharpe ratio of your optimal risky portfolio? Explain

b. Following (a), do you prefer that the removed risky asset has returns with high or with low correlation with the returns of the remaining four risky assets? Explain.

c. Assume that all the employees in the company have mean-variance preferences. That is, they care about the return-standard deviation tradeoff. Besides, Ken is less risk averse than Tim. Also assume that they have identical expectations about the properties of the returns of the four remaining risky assets. Will Ken hold the same complete portfolio as Tim? Explain.

d. Will Ken hold the same risky portfolio as Tim? Explain.

Answer rating: 100% (QA)

a The Sharpe ratio of the optimal risky portfolio will likely decrease The Sharpe ratio measures the ... View the full answer