Suppose you are a fund manager who considers investing in the following three mutual funds: a stock fund (S) with an expected return of 18% and a return standard deviation of 25%, a long-term government bond fund (B) with an expected return of 9% and a return standard deviation of 12%, and a risk-free money market fund (F) with a rate of return of 5%. The return correlation between the two risky funds, S and B, is 0.25.
Suppose now that the risk-free money market fund, F, becomes available. Assume that short selling is allowed for all three assets.

What are the weights on the two risky funds, S and B, consisting of the optimal risky portfolio (T)? What are the expected value and the standard deviation of the rate of return on the optimal risky portfolio? Draw an efficient frontier and indicate the locations of F and T. What is the reward-to variability ratio of the best feasible capital allocation line (CAL)?

Answer rating: 100% (QA)

A B C 1 2 3 stock fund 18 25 4 bond 9 12 5 6 Correlation 02500 7 8 Covariance 00075 9 10 ... View the full answer