Answer:
a. The portfolio weights that remove all risk is 50%
.
b. The risk-free rate of interest in this economy is 13.5%
Explanation:
The formula for standard deviation of a portfolio, of which i cannot type:
a. If we let sigma p = std. deviation of portfolio
rho 1,2 = correlation
if sigma = 0 and rho = -1, then the first equation can be re-written as :
0 = w1^2 * s1^2 + w2^2 * s2^2 + 2 * w1 * w2 * s1 * s2 * -1
0 = (w1s1 - w2s2)^2
w1s1 = w2s2
w1 * 0.03 = w2 * 0.03
w1 = w2 = 50%
Therefore, The portfolio weights that remove all risk is 50%
.
b. Expected return of the portfolio = 0.5*20% + 0.5*7%
= 13.5%
This portfolio has zero risk, risk free rate = 13.5%
Therefore, The risk-free rate of interest in this economy is 13.5%
