Question

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a sure rate of 5.4%. The probability distributions of the risky funds are:   

	Expected Return		Standard Deviation
Stock fund (S)	15	%	44	%
Bond fund (B)	8	%	38	%

The correlation between the fund returns is .0684.

Suppose now that your portfolio must yield an expected return of 13% and be efficient, that is, on the best feasible CAL.

What is the proportion invested in each of the two risky funds? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Stocks ________%

Bonds ________%

Answer 1

Portfolio Ret = weighted avg ret of securities in that portfolio.

Stock	Weight	Ret	WTd Ret
Stock	y	0.1500	0.15y
Bond	1-y	0.0800	0.08 - 0.08y
Portfolio Ret Return			0.08 - 0.07y

Thus 0.08 - 0.07y = 0.13

0.07y = 0.13 - 0.08

= 0.05

y = 0.05 /0.07

= 0.7143 I.e 71.43%

Investment in STocks= 71.43%

Investment in Bond = 28.57%