You can invest in U.S. Treasury bill that yield 2 percent annually. If you reall

Question

You can invest in U.S. Treasury bill that yield 2 percent annually. If you reallocate some of the money in your domestic fund to the global fund, what is the best risky portfolio of the two funds, where the risky portfolio is the portfolio of only the domestic and global fund (i.e., it does not include the risk-free T-bill)? That is, what percent of the money you chose to put at risk do you want in the domestic fund and what percent do you want in the global fund?

   Annual returns

Domestic Fund         Global Fund

Expected Return:                 .10                          .08

Standard deviation:             .20                          .35

Correlation Coefficient:               .1

Explanation / Answer

Let the percentage of investment in Domestic fund be W1.

For minimum risk portfolio:

W1 =           (SD2)2 - r(SD1)(SD2)            

            (SD1)2 + (SD2)2 - 2r(SD1)(SD2)

W1 = [(0.35)2 - 0.1(0.20)(0.35)] / [(0.2)2 + (0.35)2 - 2 x 0.1 x (0.20) x (0.35)]

W1 = 0.1155 / 0.1485

W1 = 0.7778

W2 = 1 - W1 = 1-0.7778

= 0.2222

Therefore the percentage of investment in Domestic fund is 77.78%.

The percentage of investment in Global Fund is 22.22%

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