An investor is uncertain about how much to invest in two risky assets. The first asset (equity) yields an expected return of 12% and has a standard deviation equal to 8%. The second asset (debt) yields an expected return of 6% and has a standard deviation of 5%. The correlation coefficient between the returns is -0.1.
- Compute the expected return and standard deviation of the following portfolios:
|
Portfolio
|
Percentage in equity
|
Percentage in debt
|
|
1
|
75
|
25
|
|
2
|
50
|
50
|
|
3
|
25
|
75
|
|
Portfolio
|
% in debt
|
% in eq
|
ExRet
|
Var
|
SD
|
|
3
|
0.75
|
0.25
|
0.075
|
0.001731
|
0.041608
|
|
2
|
0.5
|
0.5
|
0.09
|
0.002125
|
0.046098
|
|
1
|
0.25
|
0.75
|
0.105
|
0.003681
|
0.060673
|
- Sketch the set of portfolios composed of debt and equity in the mean-standard deviation space and identify portfolios 1, 2 and 3.
- Would a rational risk-averse investor ever choose a portfolio entirely composed of debt? Would a rational risk-averse investor ever choose a portfolio entirely composed of equity?