Question

The optimal risky portfolio offers an expected return of 12.8% and a standard seviation of 13.79%. Emily has a risk aversion of 7. The risk free rate is 4%. How much should she allocate to risk free asset?

62%

66%

45%

34%

Answer #1

Expecte Return= | 12.80% |

Risk Free Return= | 4% |

Risk Aversion= | 7% |

Varance= | 13.79%x 13.79% |

= | 1.902% |

Optimal Risky Asset (%)= | [Portfolio Expected Return { E(rp)} - (rf)] / (Risk aversion x Variance) |

= | [12.8%-4%]/ ( 7 x 1.902) |

= | 8.8/13.314 |

= | 0.661 |

Optimal Risky Asset (%)= | 66% |

Risk Free Asset (%)= | 1- Optimal risk asset |

Risk Free Asset (%)= | 1-0.66 |

Risk Free Asset (%)= | 0.34 |

Risk Free Asset (%)= | 34% |

She should allocate 34 % in risk free asset.

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