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Economics

Question: Suppose you have some money to invest-for simplicity, $1-and you are planning to put a fraction w into a stock market mutual fund and the rest, 1- w, into a bond mutual fund. Suppose that $1 invested in a stock fund yields Rs after 1 year and that $1 invested in a bond fund yields Rb, suppose that Rs is random with mean 0.08 (8%) and standard deviation 0.07, and suppose that Rb is random with mean 0.05 (5%) and standard deviation 0.04.The correlation between Rs and Rb is 0.25. If you place a fraction w of your money in the stock fund and the rest, 1 - w, in the bond fund, then the return on your investment is Rs = wRs + (1- w)Rb.

a. Suppose that w = 0.5. Compute the mean and standard deviation of R.

b. Suppose that w = 0.75. Compute the mean and standard deviation of R.

c. What value of w makes the mean of R as large as possible? What is the standard deviation of R for this value of w?

d. (Harder) What is the value of w that minimizes the standard deviation of R? (Show using a graph. algebra, or calculus.)

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