A hedge fund currently has a portfolio of securities with an expected return of 12% and a standard deviation of 20%. It is considering reallocating 20% of its assets to a catastrophe bond with an expected return of 6% and a standard deviation of 30%. The catastrophe bond has zero correlation with the other securities in the portfolio. If it does the reallocation, it would sell a proportionate amount of all of its existing securities, so that the funds not reallocated would have the same expected return and standard deviation as the original portfolio (12% and 20%). Calculate the expected return and standard deviation of the portfolio with the catastrophe bond.
Label the graph below with the expected return on the vertical axis and standard deviation on the horizontal axis. Plot and label the hedge fund's current portfolio and the portfolio with the catastrophe bond.
Do you think reallocating the portfolio is a good idea? __________
Briefly explain why it is possible for someone else to answer the previous question differently than you.