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Oil prices and airlines stock prices tend to have a strong negative correlation (planes burn...

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Finance

Oil prices and airlines stock prices tend to have a strong negative correlation (planes burn a lot of oil). Assume this correlation is 1. Moreover, assume that the return to holding oil is 10%, with a volatility of 25%, while the return of airline stocks is 9% with a volatility of 15%. Answer the following questions.

1. What is the MVP between these two risky assets?

2. Suppose that the risk-free rate is 3%. Is there an arbitrage opportunity? If so, design a trading strategy that profits from it.

3. Remove now the risk-fre asset, and sketch the MVP and the two risky assets in the standard-deviation/expected return space. Without any calculation, find a tangency portfolio and characterize its weights. Is it unique?

4. Suppose that you are mean-variance optimizer and your risk aversion is = 1. What is your optimal portfolio?

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