Question

A two-asset economy comprises assets with the following parameters:

Asset 1 Asset 2 Expected return 26% and 16%, Variance of returns 25% and 9% The correlation coefficient of returns between the two assets is 0.3.
Find the Markowitz Efficient Frontier in this economy.

Answer 1

The Markowitz Efficient Frontier is found using Modern Portfolio Theory by calculating expected returns and variances of various portfolio combinations of the two assets, based on their individual expected returns, variances, and correlation coefficient, and then plotted on a graph.

Step-by-step explanation:

The question asks for finding the Markowitz Efficient Frontier in an economy with two assets. This involves using the expected returns, variances, and correlation coefficient between the assets to determine the set of optimal portfolios that offer the highest expected return for a given level of risk.

Given that Asset 1 has an expected return of 26% with a variance of 25%, and Asset 2 has an expected return of 16% with a variance of 9%, and that the correlation coefficient between their returns is 0.3, we use the Modern Portfolio Theory to calculate the expected return and variance for a portfolio composed of a combination of these two assets.

To construct the efficient frontier, one would calculate the expected returns and variances of portfolios with varying proportions of Asset 1 and Asset 2. The efficient frontier would then be plotted on a graph with portfolio variance on the x-axis and expected return on the y-axis, showing the set of portfolios with the highest expected return for each level of risk.