Chapter 8, Problem 8PS

Portfolio risk and return Percival Hygiene has $IO million invested in long-term corporate bonds. This bond portfolio's expected annual rate of return is 9%, and the annual standard deviation is 10%. Amanda Reckonwith, Percival’s financial adviser, recommends that Percival consider investing in an index fund that closely tracks the Standard & Poor's 500 Index. The index has an expected return of 14%, and its standard deviation is 16%.

1. a) Suppose Percival puts all his money in a combination of the index fund and Treasury bills. Can he thereby improve his expected rate of return without changing the risk of his portfolio? The Treasury bill yield is 6%.
2. b) Could Percival do even better by investing equal amounts in the corporate bond portfolio and the index fund? The correlation between the bond portfolio and the index fund is + .l.