A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a sure rate of 4.8%. The probability distributions of the risky funds are:
expected return standard deviation
stock fund(s) 18% 38%
bond fund(b) 9 32
1) Tabulate and draw the investment opportunity set of the two risky funds. Use investment proportions for the stock fund of 0% to 100% in increments of 20%. What expected return and standard deviation does your graph show for the minimum-variance portfolio?
2) Draw a tangent from the risk-free rate to the opportunity set. What does your graph show for the expected return and standard deviation of the optimal risky portfolio?