Suppose you can invest your money in two assets: A and B. Asset A is risky...

 

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Suppose you can invest your money in two assets: A and B. Asset A is risky and its rates of return depend on the state of the economy as follows: State Boom Probability 0.3 Moderate Growth 0.4 Recession 0.3 Rate of return on A (%) 64 20 -23 Asset B is risk free with the rate of return of 5%. (a) Compute the expected return on asset A and its standard deviation. (b) Compute the expected rate of return and standard deviation of your portfolio if you invest a proportion w of your money the asset A and 1-w in asset B. (c) In a graph, represent the different combinations of the portfolio expected return and standard deviation, (rp.p), you can obtain by varying w. Label on the graph the points corresponding to the following values of w: 0, 0.25, 0.5, 1. (d) Suppose you decide to adhere to the following rule when constructing your portfolio: never accept portfolios which have standard deviation that is larger than the expected value of the portfolio return. What is the maximum proportion w that you can invest in A without violating this rule? Illustrate your answer on a graph. (e) Does the rule described in (d) guarantee that you will never lose money on your investment? Explain your answer. Suppose you can invest your money in two assets: A and B. Asset A is risky and its rates of return depend on the state of the economy as follows: State Boom Probability 0.3 Moderate Growth 0.4 Recession 0.3 Rate of return on A (%) 64 20 -23 Asset B is risk free with the rate of return of 5%. (a) Compute the expected return on asset A and its standard deviation. (b) Compute the expected rate of return and standard deviation of your portfolio if you invest a proportion w of your money the asset A and 1-w in asset B. (c) In a graph, represent the different combinations of the portfolio expected return and standard deviation, (rp.p), you can obtain by varying w. Label on the graph the points corresponding to the following values of w: 0, 0.25, 0.5, 1. (d) Suppose you decide to adhere to the following rule when constructing your portfolio: never accept portfolios which have standard deviation that is larger than the expected value of the portfolio return. What is the maximum proportion w that you can invest in A without violating this rule? Illustrate your answer on a graph. (e) Does the rule described in (d) guarantee that you will never lose money on your investment? Explain your answer.