✏️ Book Problems (Chapter 7)

Chapter 7 Questions 4 to 7

Status

For now, we’re skipping questions 1-3. We should probably return to them later!

Questions 4, 7, and 8 are not helpful for this class.

The following data apply to Problems 5 and 6: A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term bond fund, and the third is a money market fund that provides a safe return of 8%. The characteristics of the risky funds are as follows:

	Expected Returns	Standard Deviation
Stock fund (S)	20%	30%
Bond fund (B)	12	15

The correlation between the fund returns is ρ = 0.10.

Question 5

✏️ Tabulate and draw the investment opportunity set of the two risky funds. Use investment proportions for the stock fund of 0% to 100% in increments of 20%.

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The answer is illustrated in the following spreadsheet.

Chapter 7 Questions 4 to 7

Question 6

✏️ Draw a tangent from the risk-free rate to the opportunity set. What does your graph show for the expected return and standard deviation of the optimal portfolio?

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The answer is illustrated in the following spreadsheet. Look for the hand-drawn line.

Chapter 7 Questions 4 to 7