Question

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 14% and a standard deviation of return of 26%. Stock B has an expected return of 9% and a standard deviation of return of 11%. The correlation coefficient between the returns of A and B is .5. The risk-free rate of return is 5%. The proportion of the optimal risky portfolio that should be invested in stock B is approximately _________. |

52%

73%

48%

27%

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)]= | 14.00% |

Stock B | E[R(e)]= | 9.00% |

Stock A | Stdev[R(d)]= | 26.00% |

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

Var[R(d)]= | 0.06760 | |

Var[R(e)]= | 0.01210 | |

T bill | Rf= | 5.00% |

Correl | Corr(Re,Rd)= | 0.5 |

Covar | Cov(Re,Rd)= | 0.0143 |

Stock A | Therefore W(*d)= | 0.2673 |

Stock B | W(*e)=(1-W(*d))= | 0.7327 = 73.27% |

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