Consider two mutual funds for investment. Fund 1 is a bond fund with 5% average return and 10% standard deviation (STD) risk. Fund 2 is a stock fund with 10% average return and 15% STD risk. The correlation between the two funds is −0.16.

a. Determine the portfolio’s return and risk if all the funds are invested in the bond fund only.

b. Show that an investor can increase his portfolio’s return and simultaneously reduce its risk by investing 90% in the bond fund and 10% in the stock fund.