In: Finance
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.
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%