Question: You are in a world where there are only two assets, gold and stocks. You are interested in investing your money in one, the other or both assets. Consequently you collect the following data on the returns on the two assets over the last six years.

                                     Gold              Stock Market

Average return                  8%                     20%

Standard deviation           25%                     22%

Correlation                                  -0.4

a. If you were constrained to pick just one, which one would you choose?

b. A friend argues that this is wrong. He says that you are ignoring the big payoffs that you can get on gold. How would you go about alleviating his concern?

c. How would a portfolio composed of equal proportions in gold and stocks do in terms of mean and variance?

d. You now learn that GPEC (a cartel of gold-producing countries) is going to vary the amount of gold it produces with stock prices in the US. (GPEC will produce less gold when stock markets are up and more when it is down.) What effect will this have on your portfolios? Explain.