Question

Suppose you have some money to investfor ​simplicity, ​$1and you are planning to put a fraction w into a stock market mutual fund and the​ rest, ​, into a bond mutual fund. Suppose that​ $1 invested in a stock fund yields after 1 year and that​ $1 invested in a bond fund yields ​, suppose that is random with mean ​0.07(​%) and standard deviation ​, and suppose that is random with mean ​(​%) and standard deviation . The correlation between and is . If you place a fraction w of your money in the stock fund and the​ rest, ​, in the bond​ fund, then the return on your investment is .

Answer 1

Answer and Step-by-step explanation:

Solution:

Given:

Mean = 0.08

Standard deviation = 0.07

W = 0.75

The return on investment is:

R = W * RS + (1 – W)*RB

Compute the mean and standard deviation:

Mean:

E(R) = E[ W X RS + (1 – W) X RB]

The mean of R is given:

µ = W * RS + (1 – W)*RB

= 0.75 X 0.08 + (1 – 0.75) 0.05

= 0.06 + 0.0125

= 0.0725

Variance:

Var (R) = var [ w x RS + (1 – W)RB]

Var (R) = W 2 Var (RS )+ (1 –W)2 Var (RB) + 2w (1-w)cov(RS , RB)

The standard deviation of R is given by:

∂2 = W2 X (0.07)2 + (1 – W) 2 X( 0.04)2 + 2 W (1 – W) X [0.07 X 0.04 X 0.25]

Where [0.07 X 0.04 X 0.25] is correlation between RS and RB.