Scenario 5.10:
Hillary can invest her family savings in two assets: riskless Treasury bills or a risky vacation home real estate project on an Arkansas river. The expected return on Treasury bills is 4 percent with a standard deviation of zero. The expected return on the real estate project is 30 percent with a standard deviation of 40 percent.
-Refer to Scenario 5.10. If Hillary invests 30 percent of her savings in the real estate project and remainder in Treasury bills, the standard deviation of her portfolio is:
A) 0 percent.
B) 12 percent.
C) 28 percent.
D) 30 percent.
E) 40 percent.

Question

Quizplus · Accepted Answer

The standard deviation of the portfolio can be calculated as a weighted average of the standard deviations of the individual assets. Using the formula, we get:

Standard deviation of portfolio = sqrt[(0.7)^2(0) + (0.3)^2(40^2)]
= sqrt[(0.09)(1600)]
= sqrt(144)
= 12%

Therefore, the standard deviation of the portfolio is 12 percent. The best choice for Hillary depends on her risk preferences and investment goals. If she is risk averse and wants a stable return, she should invest in Treasury bills only. If she is willing to take on more risk for the potential of higher returns, she could invest some of her savings in the real estate project, but she should be aware that the higher expected return comes with a higher risk.

Scenario 5.10: Hillary Can Invest Her Family Savings in Two Assets: Riskless