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7. (3+3+3+2) Your employer offers two funds for your pension plan, a money market fund...

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7. (3+3+3+2) Your employer offers two funds for your pension plan, a money market fund and an S&P 500 index fund. The money market fund holds 3- month Treasury bills, which currently offer a 3% safe return per year. The S&P 500 index fund offers an expected return of 10% per year with a standard deviation of 20%. a) You want to achieve an expected return of 8% per year for your portfolio. What should be the composition of your portfolio? What is the standard deviation of its returns? b) Now your employer adds an emerging-market fund to the two existing funds. The emerging- market fund offers an expected return of 10% per year, the same as the S&P 500 index fund, but with a standard deviation of 30%, higher than the S&P 500 index fund. Would you consider including the emerging-market fund as part of your portfolio? Explain. c) The correlation between the S&P 500 index fund and the emerging- market fund is zero. Consider portfolio A, which consists of 80% in the S&P index fund and 20% in the emerging- market fund. Calculate portfolio A's expected return and standard deviation. If you mix portfolio A with the money-market fund to achieve an expected return of 8%, is it better than the portfolio in part (a) of this question? Explain|

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