(40 points) Consider the two risky assets from problem 6. Now on top of those two assets we can invest in a riskless asset with return rf = 10%.

(a) If you could only invest in the risk-free asset and either stock A or stock B, would you choose A or B?. Would your answer change if the risk-free rate was rf = 4%?

(b) Now suppose that you can form portfolios of any of the three assets (stock A, stock B and the risk-free asset). What portfolio would you choose?

0. Stock A has a expected return E[rA] = 0.20, and standard deviation of = 0.30.

1. Stock B has a expected return E[rB] = 0.25, and standard deviation of = 0.40.

2. The correlation between A and B is = 0.5.