Question

You manage a risky portfolio with an expected rate of return of 20% and a standard deviation of 36%. The T-bill rate is 5%.

Your client chooses to invest 60% of a portfolio in your fund and 40% in an essentially risk-free money market fund. What are the expected return and standard deviation of the rate of return on his portfolio? (Do not round intermediate calculations. Round "Standard deviation" to 2 decimal places.)

Answer 1

Expected return on the portfolio = w(x)*E(x) + w(y)*E(y)

Standard deviation of portfolio =

where x and y are the securities

Expected return = 0.6*0.20+0.4*0.05 = 0.1400= 14.00%

Since, the risky asset has a standard deviation of 0, and the correlation between risky and risk-free portfolio is 0, the standard deviation of the portfolio is simply the the proportion of risky portfolio times the standard deviation of risky portfolio.

Standard deviation = 0.6*0.36

Standard deviation = 0.216 = 21.60%