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Question 4 Suppose a risk-free asset has a 3 percent return and a second risky asset...

Question 4

Suppose a risk-free asset has a 3 percent return and a second risky asset has a 15 percent expected return with a standard deviation of 25 percent. Calculate the expected return and standard deviation of a portfolio consisting of 15 percent of the risk-free asset and 85 percent of the second asset.

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Answer #1

Expected return of a portfolio is weighted average of the return of the components.

E(R) = w1 * R1 + w2 * R2

E(R) = 15% * 3% + 85% * 15%

E(R) = 0.45% + 12.75%

E(R) = 13.20%

Standard deviation of portfolio is mathematically represented as:

Now, standard deviation of risk free asset = 0, and its correlation of returns with risky asset is also 0.

Standard deviation of portfolio = 21.25%

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