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Suppose that you have a risky asset that provides you with an expected return of 12% per year with 20% volatility (standard deviation). Consider a risk-free asset that provides you with a 3% risk-free return.

(a) If you have $100,000 and invest 80% into the risky asset and 20% into the risk-free asset, what is the expected return and risk of your portfolio?

(b) How much will your portfolio be worth if the realized return on the risky asset is 15%?

(c) If you cannot borrow money, what is the maximum possible ex-pected return on your portfolio, and what is the minimum?

(d) If you are allowed to borrow money at the risk-free rate, how can you get a portfolio with an 18% expected return and what is the risk of this portfolio?

 


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