Question

You manage an equity fund with an expected risk premium of 10% and an expected standard deviation of 15%. The rate on Treasury bills (risk-free rate) is 5%. Your client chooses to invest $60,000 of her portfolio in your equity fund and $40,000 in a T-bill money market fund.

Required:
What is the expected return and standard deviation of return on your client's portfolio?

Answer 1

Portfolio expected return = 8%

Portfolio SD = 9%

Step-by-step explanation:

Portfolio return is a function of the weighted average return of each stock or asset invested in the portfolio. The mean return on portfolio can be calculated using the following formula,

Portfolio return = wA * rA + wB * rB + wN * rN

Where,

• w represents the weight of each stock or asset in the portfolio
• r represents the return of each stock or asset in the portfolio

Total investment in portfolio = 60000 + 40000 = 100000

Portfolio return = 60000/100000 * 10% + 40000/100000 * 5%

Portfolio return = 8%

The standard deviation of a portfolio containing one risky and one risk-free asset is calculated by multiplying the standard deviation of the risky asset by its weight in the portfolio. So, portfolio standard deviation will be,

Portfolio SD = 60000/100000 * 15%

Portfolio SD = 9%