Three of your friends (Jean, Evan, and Lee) are having an argument about investments and, because you have taken this course, have come to you for advice. The possible investments are set out in the following table. (Assume you cannot mix risky investments.)

Jean says they should all invest in portfolio A because it has the lowest risk. Evan says they should all invest in portfolio C because it has the highest return. Lee is just confused.
a. If there is no risk-free asset, can you recommend the same portfolio for each of the friends? Why or why not?
b. If the expected risk-free rate is 2 percent, can you recommend the same set of risky assets for each of the friends? Why or why not?
c. Use Equation 9-3 to complete the table below and plot it.

d. Does the existence of a risk-free asset make the friends better off? Explain yourreasoning.

Transcribed Image Text:

Risky portfolio Expected returns 8% 13% 17% Standard deviation 5% 7% 11% Portfolio of RF+A Portfolio of RF+ B Portfolio of RF+C Standard deviation Expected return Expected return Expected return 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09 0.1 0.11 0.12