Greta has risk aversion of A = 3 when applied to return on wealth over a one-year horizon. She is pondering two portfolios, the S&P 500 and a hedge fund, as well as a number of one-year strategies. (All rates are annual and continuously compounded.) The S&P 500 risk premium is estimated at 10% per year, with a standard deviation of 24%. The hedge fund risk premium is estimated at 12% with a standard deviation of 39%. The returns on both of these portfolios in any particular year are uncorrelated with its own returns in other years. They are also uncorrelated with the returns of the other portfolio in other years. The hedge fund claims the correlation coefficient between the annual return on the S&P 500 and the hedge fund return in the same year is zero, but Greta is not fully convinced by this claim. a-1. Assuming the correlation between the annual returns on the two portfolios is 0.3, what would be the optimal asset allocation? (Do not round intermediate calculations. Enter your answers as decimals rounded to 4 places.) S&P Hedge a-2. What is the expected risk premium on the portfolio? (Do not round intermediate calculations. Enter your answers as a decimal rounded to 4 places.)
Greta has risk aversion of A = 3 when applied to return on wealth over a one-year horizon. She is pondering two portfolios, the S&P 500 and a hedge fund, as well as a number of one-year strategies. (All rates are annual and continuously compounded.) The S&P 500 risk premium is estimated at 10% per year, with a standard deviation of 24%. The hedge fund risk premium is estimated at 12% with a standard deviation of 39%. The returns on both of these portfolios in any particular year are uncorrelated with its own returns in other years. They are also uncorrelated with the returns of the other portfolio in other years. The hedge fund claims the correlation coefficient between the annual return on the S&P 500 and the hedge fund return in the same year is zero, but Greta is not fully convinced by this claim. a-1. Assuming the correlation between the annual returns on the two portfolios is 0.3, what would be the optimal asset allocation? (Do not round intermediate calculations. Enter your answers as decimals rounded to 4 places.) S&P Hedge a-2. What is the expected risk premium on the portfolio? (Do not round intermediate calculations. Enter your answers as a decimal rounded to 4 places.)
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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Transcribed Image Text:Greta has risk aversion of A = 3 when applied to return on wealth over a one-year horizon. She is pondering two portfolios,
the S&P 500 and a hedge fund, as well as a number of one-year strategies. (All rates are annual and continuously
compounded.) The S&P 500 risk premium is estimated at 10% per year, with a standard deviation of 24%. The hedge fund
risk premium is estimated at 12% with a standard deviation of 39%. The returns on both of these portfolios in any particular
year are uncorrelated with its own returns in other years. They are also uncorrelated with the returns of the other portfolio in
other years. The hedge fund claims the correlation coefficient between the annual return on the S&P 500 and the hedge
fund return in the same year is zero, but Greta is not fully convinced by this claim.
a-1. Assuming the correlation between the annual returns on the two portfolios is 0.3, what would be the optimal asset
allocation? (Do not round intermediate calculations. Enter your answers as decimals rounded to 4 places.)
S&P
Hedge
a-2. What is the expected risk premium on the portfolio? (Do not round intermediate calculations. Enter your answers as a
decimal rounded to 4 places.)
Expected Risk Premium
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