Question

You are in a world where there are only two assets, gold and U.S. stocks. You are interested in investing your money in one, the other, or both assets. Consequently, you collect the following data on the returns on the two assets over the last six years.

	Gold	Stock market
Average return	8%	20%
Standard deviation	25%	22%
Correlation	- 0.4

1. If you were constrained to pick just one, which one would you choose? Explain.

(2) A friend argues that you must choose the gold. He tells you that the distribution of gold returns is positively skewed (while the distribution of stock returns is not skewed) and thinks that choosing the stock market ignores the big payoffs that you can occasionally get on gold. What would your response be? Explain. Hint: There is no right or wrong answer here, just write what you think and justify your position.

(3) How would a portfolio composed of equal proportions in gold and stocks do in terms of mean and variance? Explain and show your work.

(4) What are the proportions of gold and U.S. stocks in the minimum variance portfolio? Show your work in Excel and write your answer here.

(5) You now learn that GPEC (a cartel of gold-producing countries) is going to vary the amount of gold it produces with stock prices in the United States. (GPEC will produce less gold when stock markets are up and more when they are down.) What effect will this have on your portfolio? How would you change the composition of your portfolio? Explain.

Answer 1