There are three securities available for investment:
Security A has an expected return of 10% and standard deviation of 20%; Security B has an expected return of 15% and standard deviation of 25%;
Security C expected return of 8% and standard deviation of 0%. The covariance between the returns on the Security A and the Security B is -0.05.
a) What is the lowest level of risk (standard deviation) you can achieve by investing in the Security A and the Security B only? Show how you can create such portfolio.
b) What is the equation of the CAL connecting Security A and Security C? What is the reward-to-variability (Sharpe) ratio associated with this CAL?
c) If you decide to invest $50 in Security A and $150 in Security B, what are the expected return and the standard deviation of the resulting portfolio?
d) What should be a degree of risk aversion of an investor who is indifferent between investing in the Security A and the Security B?