Question: Looking For Answers For All These Parts. Problem 4: (a) Suppose that there are many stocks in the security market and that the characteristics of

Looking For Answers For All These Parts.

Problem 4:

(a) Suppose that there are many stocks in the security market and that the characteristics of Stocks A and B are given as follows

Stock	Expected Return	Standard Deviation
A	10%	5%
B	15%	10%
	Correlation = -1

Suppose that it is possible to borrow at the risk-free rate, r_f. What must be the value of the risk-free rate? Explain.

HINT!!! The stocks are perfectly negatively correlated.

(b) Calculate the expected return and standard deviation of an equally weighted portfolio of Stock A, Stock B and the risk-free asset.

(c) What is the optimal portfolio? Assume the investors risk aversion coefficient is given by A=4. Provide all the relevant portfolio weights for all three assets. The utility function is given below. HINT: The formula sheet contains a formula for the optimal risky portfolio for the special case of two risky assets.

U_i = E(r_i) - 0.5A_i²

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