3. Consider two assets A and B for which return distributions can be summarized

Question

3. Consider two assets A and B for which return distributions can be summarized as follows E[2B] = 790 = 4(96)2 Tz = 2% What is the risk of the minimum risk portfolio composed of these two Stocks? (Hint: Use Solver in Excel to minimize op?). Is the risk of the minimum risk portfolio below that of every constituent asset? What is the expected rate of return on the minimum risk portfolio? Consider two other assets A' and B', which are identical (in statistical summary), respectively, to A and B above except that PAB = 1. a. Draw the graph of the efficient frontier in this case b. Write down the answers to the same questions as in problem 3. 4.

Explanation / Answer

Using excel solver, we get the minimum risk portfolio is when 80% is allocated to A and 20% to B.

Expected rate of return = 80% x 3% + 20% x 7% = 3.8%

Risk = Std. Dev. = [(80% x 1%)^2 + (20% x 2%)^2]^(1/2) = 0.89%

Yes, the risk of the portfolio is lower than the lower of A or B.

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