Assume the returns for asset X follow a normal distribution with mean 3% and standard deviation 18%, while the returns for asset Y also follow a normal distribution but with mean 2% and standard deviation 16%. The correlation between these assets is estimated to be -0.3. Assume a risk-free rate of 1%.

a) Write out the formula for the expected return using w for the weight of asset X. Calculate the return of a portfolio containing 50% of asset X and 50% of asset Y. Show your work.

b) Write out the formula for the standard deviation of the portfolio and calculate it. Show your work.

c) In terms of excess return per unit of risk, which of the three options would an investor rationally pick: 

(1) only asset X, 

(2) only asset Y or 

(3) the portfolio. 

Briefly comment on your choice. Show your work.

Answer rating: 100% (QA)

a The formula for the expected return of a portfolio containing two assets X and Y with weights wX a... View the full answer