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Decision Making (4th Edition)
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Chapter 14, Problem 94P Bookmark Show all steps: ON Continue to post
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Problem

You have $50,000 to invest in three stocks. Let Ri= be the random variable representing the annual return Snap a photo from your phone to post a question We'll send
on $1 invested in stock i. For example, if Ri 0.12, then $1 invested in stock i at the beginning of a year is download link
worth $1.12 at the end of the year. The means are E(R1) 0.14, E(R2) = 0.11,
and E(R3) = 0.10. The variances are Var R1 = 0.20, Var R2 = 0.08, and Var R3 0.18. The correlations are
r12 = 0.8, r13 0.7, and r23 0.9. Determine the minimum-variance portfolio that attains an
expected annual return of at least 0.12. 888-888-8888 Text me

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Step-by-step solution

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Step 1 of 3

The data model is given below.

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Step 2 of 3

The cash in hand is $50,000 for investing in three stocks. The expected annual return per dollar invested,
variance and the correlation between the returns is given. Obtain the covariance matrix using the
correlations and the standard deviations of the three investment returns.
Let the decision variable be the fraction of the investment amount invested in all of these three
investments. The total fraction invested is the sum of fractions invested in each investment
which should be 1. The actual return is the sum of product of fraction invested and the mean returns.
This value should be at least 0.12.

Comment

Step 3 of 3

The portfolio variance is obtained using the following formula.

 Then the portfolio variance is to be minimized so as to satisfy all the constraints with decision variables as
the changing cells. The optimal suggests investing a fraction of 0.333 in Stock 1 and 0.667 in stock 2 and
no investment in stock 3. Multiply these fractions by the amount in hand to get the actual amount invested
in each stock.

The minimum-variance portfolio is obtained by investing $16,666.66 in Investment 1 and

$33,333.34 in Investment 2.

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