Homework 3 UNIVERSITY OF MINNESOTA ECON 4751 – Financial Economics Due Thursday, October 15, 2015 Instructions: Please answer all questions clearly…

Problem 6: An investor is considering investing $100,000 in three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a risk-free rate of 5 percent. Returns on the stock fund and the bond fund have a correlation coefficient of 0.1 and the following characteristics:

Description Stock fund Bond fund

Expected Return 17 %
9%

Standard deviation 20%
12%

Solve the following exercises in the order you think appropriate, but please make sure you answer all of them.

1. A:  When picking the optimal risky-portfolio, how much will the investor invest in each of the risky mutual funds?
2. B:  What is the expected value, standard deviation and the Sharpe ratio of the optimal risky portfolio?
3. C:  If the investor has a standard utility function over returns and has a risk aversion coefficient of 3, how much will the investor invest in the risk-free mutual fund?
4. D:  What is the expected value, standard deviation and the Sharpe ratio of the optimal portfolio?