Problem
A pension fund manager is considering three mutual funds: a stock fund, a long-term bond fund and a money market fund that provides a risk-free return of 8%. Correlation coefficient between the fund returns is 0.15. The first two moments of the risky funds are as follows:
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Expected return
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Standard deviation
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Stock fund (S)
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20%
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30%
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Bond fund (B)
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12%
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15%
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1. Mr Richard wants to invest $10,000 in the optimal risky portfolio consisting of stock fund and bond. How much fund should he invest in stock fund? In bond fund?
2. Compute the expected return of the optimal risky portfolio.