Posted: January 10th, 2017

# What difference would the availability of a risk-free asset yielding 5  percent per annum make to the risk return frontier you have drawn in (a) above?

1. Two assets A and B are available for investment. Asset A has an expected return of 12 percent per annum and a standard deviation of 10 percent. Asset B has an expected return of 18 percent and a standard deviation of 20 percent. Assume two portfolios are being considered (i) comprised 25 percent of A and 75 percent in B, and, (ii) comprised 75 percent of A and 25 percent of B. The correlation coefficient between A and B is 0.6. (The variance of the two assets
 portfolio is σ 2 = w 2σ 2 + w 2σ 2 + 2w w 2 ρ 1, 2 σ  σ 2 ) p 1 1 2 2 1 1 (a) Calculate the rates of return and standard deviations for the above  two portfolios, and draw an approximate diagram illustrating the possible return and risk combinations (opportunity set). (b) What difference would the availability of a risk-free asset yielding 5  percent per annum make to the risk return frontier you have drawn in (a) above? What are the benefits to investors of the risk free asset. State all assumptions you make (supporting calculations are not required). (c) Discuss the extension of the two asset portfolio to a many asset  portfolio. What conclusions can be drawn?

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