Recap Exercises Portfolio Theory - Solution

a) The expected return and standard deviation are given by

E (r) = !1 E (r1 ) + !2 E (r2 )

(r) = !12 2
1 + !22 2
2 + 2!1 !2 1 2

i) E (r) = 0:02 and (r) = 0:065

ii) E (r) = 0:02 and (r) = 0:085
iii) E (r) = 0:02 and (r) = 0:101
iv) All portfolios consist of long/long positions meaning that the portfolio standard
deviation is increasing in the correlation. Intuition: The more the assets move together
the higher the risk of the portfolio since we hold a positive amount of each asset.

b)
i) The weight on asset 1 is !1 = 2
1+ 2
= 0:652, while the weight on asset 2 is !2 =
1 !2 = 0:348:
ii) The expected return is 1.69% and the standard deviation is zero.

c)
i) We use the CAL:
E (rP ) rf
E (ri ) = rf + i
P

and …nd that a standard deviation of 0.45 corresponds to an expected return of 9.65%.

ii) We note that the standard deviation is given by:

E (ri ) rf
i = E (r P ) r f
P

Thus, an expected return of 10% correspond to a standard deviation of 46.97%.

d)
i) The optimal fraction in the risky portfolio

E (rP ) rf
y= = 0:147
A P2
ii) The expected return of Portfolio C is given by:

E (rC ) = rf + y (E (rP ) rf ) = 2:48%

The standard deviation is:

C =y P = 4:42%
The utility is 0.021.
iii) The weight on asset 1 in the complete portfolio is (1 y) !1 = 0:56: