Reference no: EM132851135

Your best friend from high-school, Erlich, is contemplating dividing his portfolio between two assets, shares of BLESSLA (a transportation company that makes vehicles without front grills) which have an expected return of 30% and a standard deviation of 90%, and a safe asset, government debt, that has an expected return of 2% and a standard deviation of 0%.

a. If Erlich invests x percent of his wealth in the risky asset, what will his expected return be? What will the standard deviation be?

b. Solve for Erlich's "budget constraint"- i.e. the expected return on his wealth as a function of the standard deviation (Hint: Combine the two quantities from part(a).)

c. Erlich's utility function is ??(????, σ?? ) = ??????(????, 0.2 - 0.05σ?? ). What are his optimal values of ???? and ??x (Hint: Set this up as two equations in two unknowns, one of the equations is the "budget constraint.").

d. What fraction of his wealth should Erlich invest in the safe asset?