Question

To maximize your utility what would be your allocation in the risk-free asset?

risk-free asset with a return of 15%, Standard Deviation of 40%, and risk-free asset with risk-free= 5%, Pab= -1

Answer 1

Given:

Option 1] Risk-free asset with a return of 15%, Standard Deviation of 40%

Option 2] Risk-free asset with risk-free= 5%, Pab= -1 (Assuming the portfolio comprising of assets a & b are negatively correlated in terms of returns)

Answer. Option 2 Because - Negative Correlation defines diversification of the assets which means the risk is diversified. And though return is just 5% in the risk free asset, it is better than higher volatility of the portfolio that is S.D. of 40%.