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%