Bert Smith, CFA, recommends three equity funds for his new client Walter Clay. Smith uses meanvariance analysis and optimization to derive allocation decisions. Clay admittedly knows little about investing beyond some knowledge of the benefits of diversification. Smith gathers data on the following three funds, along with his recommended allocation:

Fund	Expected Return	Standard Deviation	Allocation
Blue Sky	8%	18%	60%
Green Earth	12%	25%	30%
Red Space	14%	31%	10%

The correlation matrix:

Fund	Blue Sky	Green Earth	Red Space
Blue Sky	1.00
Green Earth	0.63	1.00
Red Space	0.39	0.41	1.00

Clay asks for a detailed explanation from Smith on efficiency and correlation as well as the possibility of adding a riskfree security to the suggested portfolio. Smith responds with two observations:

• Observation 1: We could add a riskfree government bond fund and this would provide more efficient allocation choices.
• Observation 2: Adding a riskfree government bond fund will have significant diversification benefits because the correlation between the government bond fund and the suggested portfolio is likely to be negative.

Finally, Smith informs Clay that another fund, Core Fund, might be a good addition to his portfolio because it has an expected return of 15% and a standard deviation of 28%.

The expected return and standard deviation of the threefund portfolio is closest to:

	Expected Return	Standard Deviation
A.	0.098	0.033
B.	0.098	0.182
C.	0.113	0.182

Group of answer choices

A. Row A

B. Row B

C. Row C