Exercise 1

A pension fund manager is considering four mutual funds. The first is a US stock fund, the second a long-term government and corporate bond fund, the third is a commodity funds, and the fourth a T-bill money market fund that yields a rate of 6%. You know the following information about the risky funds:

Expected return (ER) Standard deviation (SD)

Stock Fund (S) :16% (ER), 25% (SD)

Bond fund (B) 12% (ER), 15% (SD)

Commodity fund (C) 10% (ER), 10% (SD)

The correlation between the stock and fund return is 0.4. The correlation between the stock and commodity return is 0.1. The correlation between the bond and commodity return is 0.2.

b. What are the proportions of each asset and the expected return and standard deviation of the tangency portfolio?

c. What is the Sharpe ratio of the best feasible CAL?