Greta, an elderly investor, has a degree of risk aversion ofA = 4 when applied to return on wealth over a one-yearhorizon. She is pondering two portfolios, the S&P 500 and ahedge fund, as well as a number of 1-year strategies. (All ratesare annual and continuously compounded.) The S&P 500 riskpremium is estimated at 9% per year, with a SD of 18%. The hedgefund risk premium is estimated at 5% with a SD of 25%. The returnson both of these portfolios in any particular year are uncorrelatedwith its own returns in other years. They are also uncorrelatedwith the returns of the other portfolio in other years. The hedgefund claims the correlation coefficient between the annual returnson the S&P 500 and the hedge fund in the same year is zero, butGreta is not fully convinced by this claim.
a-1. Assuming the correlation between theannual returns on the two portfolios is indeed zero, what would bethe optimal asset allocation? (Do not round intermediatecalculations. Enter your answers as decimals rounded to 4places.)
s&p =
Hedge =
a-2. What is the expected risk premium on theportfolio? (Do not round intermediate calculations. Enteryour answers as decimals rounded to 4 places.)
