Question

The following table provides two risky assets for you to construct the investment opportunity sets based on the given correlation information.

Constructing investment opportunity sets

Complete the table of Risks and Returns of all the possible combinations.

For each correlation situation, insert a “Mean-Standard Deviation” chart and plotting the investment opportunity sets with varying weights on the two risky assets, then connecting the dots to show the curvature of each investment set.

Given a risk-free of 3%, draw a capital allocation line (CAL) to connect the risk-free rate and the “optimal portfolio” point on each curvature chart.

Please complete on excel and show work

Assets	Expected return	Risk (STD)
A	10%	25%
B	6%	12%
Risk-free	3%	0%

		Correlation	Coeffiecient	between	asset A	and B
		-1	-0.5	0	0.5	1
Weight in Asset A	Return of the portfolio (Rp)	STD(P)	STD (P)	STD (P)	STD (P)	STD (P)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%

Answer 1

Solution:

Step1: Have to fill in the table for the investment opportunity curves for different correlation coefficients, the formulas.

Step2: Calculate the proportion for optimal risky portfolio for different correlation coefficients

Step3: For plotting on the graph , you have to first plot the investment opportunity curves by inserting scatter curve in Excel, and taking standard deviation on X axis and expected return on Y-axis, do this step for each correlation coefficient . The standard deviation will change but the expected return column will remain the same for Y-axis.

Step4: plot the risk free rate and the optimal portfolio, select the expected return for the optimal portfolio and risk free return as expected return on Y axis in the scatter and then select the standard deviations for themwhich you can see in the optimal risky portfolio calculations, this will give you a straight line from risk free asset to the optimal portfolio on the investment opportunity curves , do this step for all correlation coefficients.

2 expected return 3 standard deviation 0.25 covariance 0.03 0.015 0.015 5 risk free rate 6 excess return 7weight in A 0.03 correlation 0.07 0 0.03 correlation 1correlation -0.5 correlation 0 correlation 0.5 correlation 1 Weight in Expected retu standard deviation 12.00% 8.30% 4.60% 0.90% 2.80% 6.50% 10.20% 13.90% 17.60% 21.30% 25.00% standard deviation 12.00% 9.79% 8.32% 7.99% 8.94% 10.83% 13.27% 16.01% 18.91% 21.92% 25.00% standard deviation standard deviation standard deviation 12.00% 11.09% 10.82% 11.26% 12.32% 13.87% 15.75% 17.87% 20.14% 22.53% 25.00% 12.00% 12.24% 12.85% 13.78% 14.96% 16.35% 17.89% 19.55% 21.30% 23.12% 25.00% 6.00% 6.40% 6.80% 13.30% 14.60% 15.90% 17.20% 0.2 7.60% 8.00% 8.40% 8.80% 9.20% 9.60% 10.00% 19.80% 21.10% 22.40% 23.70% 25.00% 0.9 20 optimal weights 21 correlation-1 22 risk free rate 23 correlation -0.5 24 risk free rate 25 correlation 0 Expected returnstandard deviation 0.00% 0.00% 8.17% 0.00% 11.72% 0.324324 0.675675676 0.03 7.33% 0.03 7.40% 0.332649 0.667351129 0.349636 0.650364204