Consider two stocks (1 and 2) with expected returns E[r1]=10% and E[r2]=12%, standard deviations 1=10% and 2=15% and a correlation of 0.5. The risk-free rate in the economy is 5%. Now consider four portfolios A, B, C, and D that are constructed by investing in stocks 1 and 2, as well as the risk-free asset.

The portfolios have the following expected returns E[rP] and standard deviations :

A: E[rP] 7.85% 10.7%

B: E[rP] 10.9% 10.2%

C: E[rP] 5.1% 10.2%

D: E[rP] 12% 9.8%

It is known that one of these portfolios is a tangency portfolio and D is the minimum variance portfolio (i.e., a portfolio that invests in only stocks 1 and 2, and has the lowest variance among all portfolios of stocks 1 and 2).

Identify the tangency portfolio and its weights in stocks 1, 2, and the riskless asset?

Answer rating: 100% (QA)

Heres how to identify the tangency portfolio and its weights 1 Analyze the Minimum Variance Portfolio D We know that portfolio D is the minimum varian... View the full answer