Microsoft Word - Final Exam Fall 2013 updated
Given:
- Risk free rate = 4%.
- FundW:E[rw]=14%,σw =20%
- FundX:E[rX]=24%,σX =30%
- FundY:E[rY]=34%,σY =40% You have mean-variance preferences and utility function:
U = E(rp) - 2σp2
a) Assume that you have to invest exactly 100% of your wealth in one of the above three funds and that you can't trade anything else. Can you say which fund you would select based on the given utility function? If yes, justify your answer by showing the relevant calculations. If no, explain briefly why not.
b) Assume that you must still select only one of the above three funds, but that you are free to invest any weight you want in that fund and that you can also borrow or lend at the risk free rate. Based on this new assumption, can you say which fund you would select to mix with the risk free asset? If yes, justify your answer by showing the relevant calculations. If no, explain briefly why not. (You do not need to construct the optimal portfolio.)