There are only two assets available to investors: 1) A stock fund with an expected return of 12% and a return standard deviation of 20%; and 2) A bond fund with an expected return of 7% and a return standard deviation of 8%. The correlation between the stock fund’s return and the bond fund’s return is -0.2. Mary is a risk-averse investor. Answer the following questions:
a. If Mary invests 5% of her portfolio wealth in the stock fund and 95% in the bond fund (She invests nothing in the risk free asset). What is the expected return and standard deviation of her portfolio?
b. If Mary invests 100% of her portfolio wealth in the bond fund, what is the expected return and standard deviation of her portfolio?
c. Which portfolio between a) and b) would Mary prefer? Explain your answer.