1. Use the following information to answer the questionsbelow:

SecurityReturn(S1)Return(S2)

A16%20%

B12%25%

Risk-free assetreturn =4%

S1 is State-1 and S2 is State-2;

Prob(S1) = 0.6;Prob(S2) = 0.4

i).What is the expected return on Security A and the expected return on Security B?

(2 points)

ii).What is the portfolio expected return with 140%of wealthinvested in A and the remainder in the risk-free asset via borrowing at the risk-free interest rate?(3 points)

Problem 3(continued)

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government andcorporate bond fund, and the third is a T-bill money market fundthat yields a sure rate of 5.5%. The probability distributions of therisky funds are:

Expected Return

Standard Deviation

Stock fund (S)

15%

32%

Bond fund (B)

9

23

The correlation between the fund returns is 0.15.

What is the Sharpe ratiofor the minimum variance portfolio (MVP)?(5 points)

[Hint: The minimum-variance CAL is the line joining the risk-free asset to the minimum-variance portfolio (MVP). Now calculate slope of lineafter characterizing the minimum-variance portfolio.]