Final answer:
- a) In order to determine the standard deviation of the portfolio, use the weighted standard deviation formula.
- b) In order to find the proportion invested in each fund, use the equations for expected return.
Step-by-step explanation:
a) In order to determine the standard deviation of the portfolio, we need to use the formula for the weighted standard deviation. The formula is:
Standard Deviation of Portfolio = (wS)² x (Standard Deviation of Stock Fund)² + (wB)² x (Standard Deviation of Bond Fund)²+ 2 x wS x wB x (Standard Deviation of Stock Fund) x (Standard Deviation of Bond Fund) x (Correlation Coefficient)
By plugging in the given values, we can calculate the standard deviation of the portfolio:
Standard Deviation of Portfolio = (wS)² x 36%² + (wB)² x 27%² + 2 x wS x wB x 36% x 27% x 0.15
b) To find the proportion invested in the T-bill fund and each of the two risky funds, we can use the following equations:
Expected Return of Portfolio = (wS) x (Expected Return of Stock Fund) + (wB) x (Expected Return of Bond Fund) + (1 - wS - wB) x (Expected Return of T-bill Fund)
wS + wB + (1 - wS - wB) = 1
By solving these equations, we can determine the proportion invested in each fund.
Your question is incomplete, but most probably the full question was:
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) 16% 36%
Bond fund (B) 10% 27%
The correlation between the fund returns is 0.15.
Suppose now that your portfolio must yield an expected return of 12% and be efficient, that is, on the best feasible CAL.
a. What is the standard deviation of your portfolio?
b. What is the proportion invested in the T-bill fund and each of the two risky funds?