Suppose that Ms.Lynch can make up her portfolio using a risk-free asset that offers a surefire rate of return of 10% and a risky asset with an expected rate of return of 20%, with standard deviation 5.If she chooses a portfolio with an expected rate of return of 17.50%, then the standard deviation of her return on this portfolio will be

A) 3.75%.
B) 7.50%.
C) 6.75%.
D) 1.88%.
E) None of the above.

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Vinni Munjal · Accepted Answer

Final Answer : A, Explanation :  The standard deviation of a portfolio that combines a risk-free asset and a risky asset is proportional to the amount invested in the risky asset. Since the expected return of the portfolio is 17.50%, which is 75% of the way from the risk-free rate of 10% to the risky asset's expected return of 20%, the standard deviation of the portfolio will be 75% of the risky asset's standard deviation. Thus, 0.75 * 5% = 3.75%.

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