Suppose Janet is choosing how to allocate her portfolio betweentwo asset classes: risk-free government bonds...

Suppose Janet is choosing how to allocate her portfolio between two asset classes: risk-free government bonds and a risky group of diversified stocks. The following table shows the risk and return associated with different combinations of stocks and bonds.

There is a _______ relationship between the risk of Janet's portfolio and its average annual return.

Suppose Janet 75% currently allocates of her portfolio to a diversified group of stocks and 25% of her portfolio to free bonds, that is, she chooses combination D. She wants to reduce the level of risk associated with her portfolio from a standard deviation of 15 to a standard deviation of 5. In order to do so, she must do which of the following? Check all that apply.

Place the entirety of her portfolio in bonds
Sell some of her stocks and use the proceeds to purchase bonds
Sell some of her bonds and use the proceeds to purchase stocks
Accept a lower average annual rate of return

The table uses the standard deviation of the portfolio's return as a measure of risk. A normal random variable, such as a portfolio's return, stays within two standard deviations of its average approximately 95% of the time.

Suppose Janet modifies her portfolio to contain 50% diversified stocks and 50% risk-free government bonds; that is, she chooses combination C. The average annual return for this type of portfolio is 4.5%, but given the standard deviation of 10%, the returns will typically (about 95% of the time) vary from a gain of _______ to a loss of _______.

Expert Solution

1) There is a direct linear relationship between the risk of Janet's portfolio and its average annual return.

What are the options for this 'fill in the blank' question ?

2) Suppose Janet currently allocates 75% of her portfolio………………..

The following options apply:

*Sell some of her stocks and use the proceeds to purchase bonds.

*Accept a lower average annual rate of return.

3) Suppose Janet modifies her portfolio…………………………….

vary from a gain of 4.5+2*10 = 24.5% to a loss of 4.5-2*10 = -15.5%

jeff jeffy answered 2 years ago

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