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a.
The expected % return for investment in all world fund is 7.80 and standard deviation is
18.90%. Similarly, the expected % return of an investment in a treasury bond is 5.50 and
standard deviation is 4.60%.
Expected return wise, world fund is lucrative but it has higher standard deviation
compared to treasury bond. More the standard deviation, more the riskiness.
b.
It is required to find the expected return for someone who invests 75% in World Fund
and 25% in treasury bonds. Expected value of linear combination of random variables x
and y is as follows:
E (ax by ) aE ( x) bE ( y ) (1)
E ( x) 7.80, E ( y ) 5.50
Assume, x denote world fund and y denote treasury bond. Substitute the values in the
equation (1) and obtain the required return. The required return is as follows:
Substitute the values in equation (2) and compute the variance of the return. The variance
is as follows:
Var (0.75x 0.25 y) 0.752 18.902 0.252 4.602 2 0.75 0.25 12.4
= 197.603125
It is required to find the expected return for someone who invests $10000 in portfolio 1(
75% in World fund and 25% in treasury bond).
E ( x1 ) 7.23%
E (10000 x1 ) 10000 E ( x1 )
= 10000 7.23
= 72300
Var ( x1 ) 14.06%
c.
It is required to find the expected return for someone who invests 25% in World Fund
and 75% in treasury bonds.
E ( x) 7.80, E ( y ) 5.50
Assume, x denote world fund and y denote treasury bond. Substitute the values in the
equation (1) and obtain the required return. The required return is as follows:
Substitute the values in equation (2) and compute the variance of the return. The variance
is as follows:
Var (0.25x 0.75 y) 0.252 18.902 0.752 4.602 2 0.25 0.75 12.4
= 29.578125
It is required to find the expected return for someone who invests $10000 in portfolio 2(
25% in World fund and 75% in treasury bond).
E ( x2 ) 6.08%
E (10000 x2 ) 10000 E ( x2 )
= 10000 6.08
= 60800
Var ( x2 ) 5.44%
Portfolio 2 has higher return, but more risky. Therefore, one who is aggressive investor
should invest in portfolio 2. Portfolio 1 has lesser return and at the same time less risky.
Therefore, for conservative investor portfolio 1 is suitable.