1. An investor is considering three mutual funds. The first two are stock funds

ID: 2778372 • Letter: 1

Question

1. An investor is considering three mutual funds. The first two are stock funds A and B, the third is a T-bill money market fund that yields a rate of 3%. The probability distribution of the risky funds is as follows:

(b) Tabulate and draw the investment opportunity set of the two risky funds. Use investment proportions for the stock fund of zero to 100% in increments of 20%. (4 points)

(c) Use your calculation results in part (b) to draw the figure of the opportunity set of stock fund A and B. (2 points)

Explanation / Answer

Investment in T-bill Money market fund Return = 3% is risk free

and investment in stock fund A and B, return is

A= B=

.30 * 7 = 2.1 .30* -9= -2.7

.50* 11= 5.5 .50*20= 10

.20 * -10= 2 .20*20= 4

Return (A)= 5.6 Return (B)= 11.3

zero of A and 100% of B

5.6*0 + 11.3*100%= 11.3

return of portfolio= risk free + risky return

= 3% + 11.3%

=14.3%

20% of A and 80% of B

5.6*20% + 11.3*80%= 10.16

= 3% + 10.16%

=13.16%

40% of A and 60% of B

5.6*40 % + 11.3*60%= 9.02

= 3% + 9.02%

=12.20%

60% of A and 40% of B

5.6* 60% + 11.3* 80%= 12.4

= 3% + 12.4%

=15.4%

80% of A and 20% of B

5.6* 80% + 11.3* 20%= 2.26

= 3% + 2.26%

=4.26%

100% of A and zero% of B

5.6*100 % + 11.3* 0%= 5.6

= 3% + 5.6%

=8.6%

Opportunity of stock A

Return of portfolio = risk free return + Risk return

= 3% + 5.6^%= 8.6%