Question

You manage a risky portfolio P that has the following characteristics: expected return = 16% and...

You manage a risky portfolio P that has the following characteristics: expected return = 16% and the standard deviation of the return of your portfolio = 20%. The risk-free rate is at 4%. Your client wants to invest a proportion of her total investment budget in your risky portfolio to maximize expected return and at the same time limit the volatility to no higher than 14% on her overall portfolio. Then the proportion she should invest in your risky portfolio is

A.

78%
B.

65%
C.

80%
D.

75%
E.

70%
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Answer #1

We are given the retrun and the standard deviation of the risky portfolio. As the stadard deviation is higher, the client will have to combine the risky portfolio with the risk free asset so that the satadard deviation or the volatility reduces.

Risk free asset has no stadard deviation and therefore, the source of entire portfolio volatility is from the risky portfolio.

To calculate the weights of the risk free and the risky assets

sigma = standard deviation

So she should invest 70% in the risky portfolio and 30% in the risk free asset

The correct answer is E

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