Question: Problem 2 (25 points)You survey a client and you conclude that she can tolerate a standard deviation T of at most 12%.You can allocate your

Problem 2 (25 points)You survey a client and you conclude that she can tolerate a standard deviation T of at most 12%.You can allocate your client's wealth into a corporate bond fund, a common stock fund, and a U.S. T-Bills (risk -free), with the following means and standard deviations:E ( Ri ) iBond fund (B) 15% 17%Common stock (S) 21% 35%U.S. T-Bill (r f 9.5% 0%The correlation between the stock fund and the bond fund is B ,S =0.7.

a) Find the optimal risky portfolio (5 points)7wB = % wS =

b) Find the expected return and risk of the optimal risky portfolio (5 points)

c) Draw the Capital Allocation Line of the optimal risky portfolio. (5 points) Clearly identify the risk and return of the optimal risky portfolio Clearly identify the risk free rate Find the Sharpe ratio of this CAL8Expected return E(R)Risk ( E(Rrisky)= % risky= SCAL=

d) Find the weights your client should allocate into the bond fund (wB), the common stockfund (wS), and into the risk-free asset (wf ). (Remember that wB + wS + wf = 1). (5 points)

e) Finally, find the return of the portfolio that you found in d). Verify that the standarddeviation of the risky portfolio is exactly 15%. (5 points)9wB = %wS = wrf= E( Rfinal)= % final=

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