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 5.5%. The probability distributions of the

risky funds are:

	Expected Return	Standard Deviation
Stock fund (S)	15%	32%
Bond fund (B)	9	23

The correlation between the fund returns is 0.15.

What is the Sharpe ratio of the best feasible CAL?

#first find the weights (Ws, Wb) for the stocks and bonds

#then after the weights for the optimal portfolio (i.e. highest Sharpe ratio/steepest part of CAL) → use Rule two to find the expected return of the portfolio and rule 3 to find std. Dev.

→ then find the sharpe ratio of these values to get the optimal risky portfolio (Steepest CAL tangent with the investment opp. Set).

Answer 1

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