Consider three risky assets with the following attributes:

Asset 1	Expected Return	Standard Deviation
	12%	22%
Asset 2	5%	10%
Asset 3	15%	18%

The risk-free rate is 2%. The covariance matrix for the assets is:

Asset 1 Asset 2 Asset 3	Asset 1	Asset 2	Asset 3
	0.0484	0.0110	0.0198
	0.0110	0.0100	0.0090
	0.0198	0.0090	0.0324

Assume short-selling is allowed.

1. What is the correlation between Asset 1 and Asset 2?
2. If one cannot invest in the risk-free security, what is the best portfolio that earns a 13% expected return?
3. Explain concisely in a sentence or two how you solved part (b).
4. What are the weights, expected return and standard deviation of the tangency portfolio?
5. Explain concisely in a sentence or two how you solved part (d).
6. If one can invest in the risk-free security (either long or short), what is the best portfolio you can hold that earns a 13% expected return? Specify the weights in the risk-free asset, Assets 1, 2 and 3 as well as the portfolio’s standard deviation.

Answer rating: 100% (QA)

Expected Return Standard Deviation variance Asset 1 12 22 00484 Asset 2 5 10 001 Asset 3 15 18 00324 ... View the full answer