A pension fund manager is considering three mutual funds. The first is a stock f

Question

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a rate of 3.0%. The probability distribution of the risky funds is as follows: The correlation between the fund returns is 0.18. Solve numerically for the proportions of each asset and for the expected return and standard deviation of the optimal risky portfolio. A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a longterm government and corporate bond fund, and the third is a T-bill money market fund that yields a sure rate of 5.3%. The probability distributions of the risky funds are: The correlation between the fund returns is .0459. What is the reward-to-volatility ratio of the best feasible CAL?

Explanation / Answer

2)

Portfolio standard deviation p for a two-asset portfolio is given by the following formula:

Portfolio Standard Deviation2A2A2B2B2ABAB

Where,
A = weight of asset A in the portfolio;
B = weight of asset B in the portfolio;
A = standard deviation of asset A;
B = standard deviation of asset B; and
= correlation coefficient between returns on asset A and asset B.

Substituting in the formulae:

Square root of (0.33)(0.33)(0.41) (0.41)+ (0.33)(0.33)(0.3) (0.3)+2*(0.33) (0.41) (0.33) (0.3)*0.18

= Square root of 0.48

=0.69 is the expected portfolio standard deviation.

Expected return is as follows:

=(12+5+3)/3

=6.67

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