The x-axis shown in the figure below measures standard deviation in portfolio returns and the y-axis measures the expected return. The curve represents the investment frontier. The frontier was created using 2 underlying risky portfolios based on stocks (#11, square portfolio) and bonds (#2, circle portfolio). The correlation between the stock and bond portfolios in this example was -0.25.

Assumptions:

• Expected return for portfolio #11 = 10%
• Expected return for portfolio #2 = 7%
• Risk free rate = 5%
• Expected return on tangency portfolio = 8%, standard deviation for tangency portfolio = 7%
• You have $10,000 of investment equity

1. Portfolio 13 is on the CAL tangent to the frontier and has an expected return of 10.3%. Which assets would you use to create portfolio 13?

Possible Answers:

A. Portfolio 13 can be created using a combination of just the risk-free asset and the tangency portfolio.

B. Portfolio 13 can be created using a combination of just the risk-free asset and the stock portfolio.

C. Portfolio 13 can be created using a combination of just the risk-free asset and the bond portfolio.

D. Portfolio 13 can be created using a combination of just the stock and the bond portfolio.

2. Portfolio 8 is on the investment frontier and has an expected return of 9.1%. How much money would you need to invest in portfolio #11 if you wanted to create portfolio #8? Assume you can only invest in portfolios 2 and 11 and that you want to use all of your investment equity.

A. We would invest $7,000 in portfolio #11 and the rest in portfolio #2 to create portfolio #8

B. We would invest $3,000 in portfolio #11 and the rest in portfolio #2 to create portfolio #8

C. We would invest $5,000 in portfolio #11 and the rest in portfolio #2 to create portfolio #8

D. We would invest $1,000 in portfolio #11 and the rest in portfolio #2 to create portfolio #8

3. When we talk about portfolio weights we use the word "shorting" synonymously with the idea of "borrowing" and this appears in the math as negative investment weights. Assume we can invest in the risk-free asset, the tangency portfolio, the bond portfolio, and/or the stock portfolio. Which of the statements below are true?

A. To create porfolios 12 and 13 we would need to short at least one asset.

B. Only porfolio 13 requires shorting in some asset to create.

c. Only porfolio 12 requires shorting in some asset to create.

c. Only porfolio 14 requires shorting in some asset to create.

D. To create porfolio 12, 13, 14 you would need to short at least one asset.

4. True/False: Portfolios 1 and 2 are on the "efficient frontier".