Suppose Teresa is choosing how to allocate her portfolio between two asset dasse

Question

Suppose Teresa is choosing how to allocate her portfolio between two asset dasses: risk-free government bonds and a risky group of diversified stocks. The following table shows the risk and return associated with different combinations of stocks and bonds. Fraction of Portfolio in Diversified Stocks (Percent) Standard Deviation of Portfolio Return (Risk) (Percent) Average Annual Return (Percent) 1.50 3.50 5.50 7.50 9.50 Combination 25 50 75 100 10 15 20 There is arelationship between the risk of Teresa's portfollio and its average annual return Suppose T positive tly allocates 25% of her portfolio to a diversified group of stocks and 75% of her portfolio to risk-free bonds, that is, she chooses c negative . She wants to increase the average annual return on her portfolio from 3.5% to 7.5%. In order to do so, she must do which of the followg creorull that apply

Explanation / Answer

There is a positive relationship between the risk of the portfolio and it's average annual return.

As we can see with the increase in risk the return increases that is risk is directly proportional to return. Hence, risk and return are positively related.

Currently she has invested 25% in stock and 75% in risk free bond. In order to increase her return from 3.5% to 7.5% she must sell some of her bonds and use the proceeds to purchase stocks.

it will vary from a gain of 10%(0.55%) to loss 10%(0.55%).

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