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Assume you manage a risky portfolio with an expected return of 8% and a standard deviation...

Assume you manage a risky portfolio with an expected return of 8% and a standard deviation of 21%. The T-bill rate is 2%. Your client chooses to invest 60% of a portfolio in your fund and 40% in a T-bill money market fund. What is the standard deviation of your client's portfolio. convert you answer into percentages and round to ONE decimal point.

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Expert Solution

Standard deviation for a two-asset portfolio σp = (w12σ12 + w22σ22 + 2w1w2Cov1,2)1/2

where σp = Standard deviation of the portfolio

w1 = weight of Asset 1

w2 = weight of Asset 2

σ1 = Standard deviation of Asset 1

σ2 = Standard deviation of Asset 2

Cov1,2 = covariance of returns between Asset 1 and Asset 2

Cov1,2 = ρ1,2 * σ1 * σ2, where ρ1,2 = correlation of returns between Asset 1 and Asset 2

Standard deviation = ((0.62 * 0.212) + (0.42 * 02) + (2 * 0.6 * 0.4 * 0))1/2

For a T-Bill, the standard deviation is zero, and its covariance with a risky asset is zero.

Standard deviation = 0.126, or 12.6%


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