Question

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 20% and a standard deviation of return of 18%. Stock B has an expected return of 11% and a standard deviation of return of 7%. The correlation coefficient between the returns of A and B is .29. The risk-free rate of return is 8%. The proportion of the optimal risky portfolio that should be invested in stock A is __________.

57%

69%

62%

47%

Answer #1

To find the fraction of wealth to invest in Stock A that will result in the risky portfolio with maximum Sharpe ratio the following formula to determine the weight of Stock A in risky portfolio should be used |

Where | ||

Stock A | E[R(d)]= | 20.00% |

Stock B | E[R(e)]= | 11.00% |

Stock A | Stdev[R(d)]= | 18.00% |

Stock B | Stdev[R(e)]= | 7.00% |

Var[R(d)]= | 0.03240 | |

Var[R(e)]= | 0.00490 | |

T bill | Rf= | 8.00% |

Correl | Corr(Re,Rd)= | 0.29 |

Covar | Cov(Re,Rd)= | 0.0037 |

Stock A | Therefore W(*d)= | 0.4728= 47% |

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