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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

## 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

= 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).

E ( x1 )  7.23%

## The required return is as follows:

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

## From information given,

Var ( x1 )  14.06%

## Var (10000 x1 )  100002 Var ( x1 )

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

= 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

## 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

= 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).

E ( x2 )  6.08%

## The required return is as follows:

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

## From information given,

Var ( x2 )  5.44%

= 100002 (5.44)
= 544000000

= 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.