Homework 3 UNIVERSITY OF MINNESOTA ECON 4751 - Financial Economics Due Thursday, February 25, 2016 Instructions: Please answer all questions clearly...

Problem 6.

An investor is considering investing $100,000 in three mutual funds. The firstis a stock fund, the second is a long-term government and corporate bond fund, and the thirdis a T-bill money market fund that yields a risk-free rate of 5 percent. Returns on the stockfund and the bond fund have a correlation coefficient of 0.1 and the following characteristics:

                           Expected Return  Standard deviation

Stock fund:                        17 %                     20%

Bond fund  :                         9%                       12%

A: When picking the optimal risky-portfolio, how much will the investor invest in each ofthe risky mutual funds?

B: What is the expected value, standard deviation and the Sharpe ratio of the optimalrisky portfolio?

C: If the investor has a standard utility function over returns and has a risk aversioncoefficient of 3, how much will the investor invest in the risk-free mutual fund?

D: What is the expected value, standard deviation and the Sharpe ratio of the optimalportfolio?