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You are attempting to construct an optimal portfolio consisting of T-bills and a risky portfolio. The expected return on the risky portfolio is 19% and the standard deviation is 25%. The T-bill rate is 5.3%.
(a) If you put 45% of your funds in T-bills and 55% in the risky portfolio, what is the expected return and standard deviation of your overall portfolio?
(b) Construct a Capital Allocation Line for a portfolio consisting of the T-bills and the risky portfolio. Draw the line and indicate the y-intercept and the point where the portfolio is entirely made up of risky assets. What is the slope of this line?
(c) Suppose that Robin has a degree of risk aversion of A = 3. What is the optimal portfolio for this investor? In other words, what is the optimal weight (y) in the risky portfolio and what is the optimal weight (1-y) in T-bills?
(d) What is the expected return and standard deviation on the optimal portfolio for Robin? Illustrate this point on your CAL graph you drew in Part (b).
(e) Now suppose Mindy has a degree of risk aversion of A = 6. What is the optimal weight (y) in the risky portfolio and what is the optimal weight (1-y) in T-bills for Mindy? Briefly explain why Mindy’s optimal weight in the risky portfolio differs from Robin’s?
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