Question

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 15% and a standard deviation of return of 25%. Stock B has an expected return of 12% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is 0.2. The risk-free rate of return is 1.5%.

1) Approximately what is the proportion of the optimal risky portfolio that should be invested in Stock B?

2) What is the Expected Return on the Optimal Portfolio?

3) What is the REWARD to VARIABILITY Ratio of the Optimal Portfolio?

Answer 1

EA = 15% EB= 12 % A = 25% B = 20% Rf = 1.5% Correlation coefficient between the returns of A and B = 0.2

1) Approximately what is the proportion of the optimal risky portfolio that should be invested in Stock B?

Weight of Stock A	0.4549 or 45.49%
Weight of Stock B	0.545 or 54.51 %

Proportion of the optimal risky portfolio that should be invested in Stock B is 0.5451 or 54.51%

What is the Expected Return on the Optimal Portfolio?

Expected Return on the Optimal Portfolio is 0.1336 =13.36%

What is the REWARD to VARIABILITY Ratio of the Optimal Portfolio?

N.B. its also call Sharpe Ratio

REWARD to VARIABILITY Ratio of the Optimal Portfolio = 0.6876 or 68.76%