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5-63SE

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.

Therefore, the world fund is considered more risky.

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)

From information given,

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:

E (0.75 x  0.25 y )  0.75 E ( x)  0.25 E ( y )


= 0.75  7.80  +0.25  5.50 
= 7.225

Therefore, the required answer is: 7.23% .

The variance of linear combination of two random variables is as follows:

Var (ax  by)  a2Var ( x)  b2Var ( y)  2ab xy (2)

From information given,

Var ( x)  18.902 ,Var ( y)  4.602 ,  xy  12.4

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

The standard deviation of the return is as follows:

SD(0.75 x  0.25 y )  Var (0.75 x  0.25 y )


= 197.603125
= 14.06

Therefore, the required answer is: 14.06% .

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).

From information given,

E ( x1 )  7.23%

The required return is as follows:

E (10000 x1 )  10000 E ( x1 )
= 10000  7.23
= 72300

Therefore, the required answer is: $72300 .

From information given,

Var ( x1 )  14.06%

The variance of return is as follows:

Var (10000 x1 )  100002 Var ( x1 )


= 100002 (14.06)
= 1406000000
The standard deviation of the return is as follows:

SD(10000 x1 )  Var (10000 x1 )


= 1406000000
= 37496.67

Therefore, the required answer is: $37496.67 .

c.

It is required to find the expected return for someone who invests 25% in World Fund
and 75% in treasury bonds.

From information given,

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:

E (0.25 x  0.75 y )  0.25 E ( x)  0.75 E ( y )


= 0.25  7.80  +0.75  5.50 
= 6.075

Therefore, the required answer is: 6.08% .

From information given,

Var ( x)  18.902 ,Var ( y)  4.602 ,  xy  12.4

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

The standard deviation of the return is as follows:

SD(0.25 x  0.75 y )  Var (0.25 x  0.75 y )


= 29.578125
= 5.44

Therefore, the required answer is: 5.44% .

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).

From information given,

E ( x2 )  6.08%

The required return is as follows:

E (10000 x2 )  10000 E ( x2 )
= 10000  6.08
= 60800

Therefore, the required answer is: $60800 .

From information given,

Var ( x2 )  5.44%

The variance of return is as follows:

Var (10000 x2 )  100002 Var ( x2 )


= 100002 (5.44)
= 544000000

The standard deviation of the return is as follows:

SD(10000 x2 )  Var (10000 x2 )


= 544000000
= 23323.81

Therefore, the required answer is: $23323.81 .


d.

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.