Suppose you have two asset classes to invest in. The first is large-cap stocks, which has an expected return of 15% (per year) and volatility of 15%. The second is a government bond index, which has an expected return of 5% and volatility of 10%. The correlation between the two is 0.50.

·      Calculate (manually) the return and volatility of a portfolio that is 75% invested in large-cap stocks and 25% invested in government bonds.

·      On a spreadsheet, plot out expected return and risk trade-off as you range the weight from 0% to 100%. Be sure to plot expected return on the vertical axis and risk on the horizontal axis.

·      See how the plots change as you change the correlation to 0.00 and to -0.50.

 
2.    Suppose that the risk-free rate is 5% and the expected return on a stock fund is 13%. An investor with $1 million to invest wants to achieve a 17% rate of return combining the risk-free asset and the stock fund.

·      How much would the investor need to deposit (or borrow) in the risk-free asset?

·      What if the investor wants to achieve a 6% rate of return?

Answer rating: 100% (QA)

1 Portfolio of LargeCap Stocks and Government Bonds Expected return of portfolio 075 x 15 025 x 5 125 Volatility of portfolio sqrt0752 x 152 0252 x 10... View the full answer