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 sure rate of 3.0%. The probability distributions of the risky funds are: Expected Return Standard Deviation Stock fund (S) 12% 41% Bond fund (B) 5% 30% The correlation between the fund returns is .0667. What is the reward-to-volatility ratio of the best feasible CAL? (Do not round intermediate calculations. Round your answer to 4 decimal places.) Reward-to-volatility ratio

Answer 1

Solution:

First, we calculate the between stock fund and bond fund,

= 0.0667 (41%) (30%)

= 82.041

7935.918/10395.47

0.7634

= 1 - 0.7634

= 0.2366

The mean and the standard deviation of the optimal risky portfolio are

= 0.7634 (12%) + 0.2366 (5%)

= 10.3438%

32.5526%

Hence, the reward-to volatility ratio is

0.2256