Jonathan is considering investing in security A that has offered average annual return of 14% and standard deviation of 18% and security B which has offered average annual returns of 11% and standard deviation of 14% in the recent past.
(a) If the correlation between A and B is 0.35, what is the least risky combination of these two assets?
Jonathan is not happy with the portfolio risk and would like to reduce this further. Jonathan does not mind taking excess risk provided he can earn an average return of 10% from the portfolio. The returns on 90-day T-bills are around 2.50% per annum. Assuming that Jonathan can borrow and lend at the risk-free rate of return, advise how much Jonathan should invest in the portfolio (comprising of security A and security B) and the risk-free asset so that the combination of risky portfolio and risk-free asset provides 10% return. How much would be invested in security A, security B, and the risk free asset and what would be the risk of the new portfolio?