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Your uncle has $2,000 invested in corporate bonds with an expected return of 9% and a...

Your uncle has $2,000 invested in corporate bonds with an expected return of 9% and a standard deviation of 9%. His financial adviser suggested that he should move his money into an Index fund that tracks the Russell 2000, which has an expected return of 15% and a standard deviation of 16%.   How could your uncle invest his money in some combination of that Index fund and risk-free T-bills that would increase his expected return without increasing his standard deviation?   Assume the risk-free rate is 2%.

Solutions

Expert Solution

Standard deviation of portfolio =

( (Weight of Asset 1 * Standard deviation of Asset 1) ^ 2) + ((Weight of Asset 2 * Standard deviation of Asset 2) ^ 2) + (2 * (Weight of Asset 1) * (Weight of Asset 2) * (Standard deviation of Asset 1) * (Standard deviation of Asset 2) * (Correlation between Asset 1 & Asset 2)

We know that correlation between Risk-free asset & Index Fund is 0

We will use Goal seek function to determine weights of asset, such that Standard deviation of overall Portfolio remains at 9%

Attaching the formulas and calculation used :-

Hence, investment in corporate bonds = (0.519 * 2000) = 1,038

investment in Index fund = (0.481 * 2000) = 962

jeff jeffy answered 1 year ago
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