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You are considering two risky investment funds
You are considering two risky investment funds. The first is a stock fund, and the second is a commodity fund. The stock fund has an expected return of 10% and a standard deviation of returns of 20%. The commodity fund has an expected return of 20% and a standard deviation of returns of 20%. The correlation of returns between the two funds is 0.0. In addition, the risk-free asset pays a risk-free rate of return of 5% per year. What is the expected return on the portfolio comprised of the two risky funds with the maximum Sharpe ratio? O 17.5% O 22.09 19.696 O 15.0%
Expert Solution
For Maximum Sharpe ratio we should calculate weights for optimally risky portfolio
For optimally risky portfolio we should using following formula
Weight of S = ((Return of S - Risk Free Rate) * (Standard Deviation B)2 - (Return of B - Risk Free Rate)*(Standard Deviation S* Standard Deviation B*Correlation Coefficient ))/((Return of S - Risk Free Rate) * (Standard Deviation B)2 +(Return of B - Risk Free Rate) * (Standard Deviation S)2 - ((Return of S - Risk Free Rate) +(Return of B - Risk Free Rate))*(Standard Deviation S* Standard Deviation B*Correlation Coefficient )))
Weight of Stock =((10%-5%)*20%^2-(20%-5%)*20%*20%*0)/((10%-5%)*20%^2+(20%-5%)*20%^2-(((10%-5%)+(20%-5%)) *20%*20%*0)) =25%
Weight of B = 1-25% =75%
Expected Return of optimally risky portfolio =25%*10%+75%*20% =17.50% (Option a is correct option)
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