Percival Hygiene has $10 million invested in long-term corporate bonds. This bond portfolio’s expected annual rate of return is 8%, and the annual standard deviation is 14%. Amanda Reckonwith, Percival’s financial adviser, recommends that Percival consider investing in an index fund that closely tracks the Standard & Poor’s 500 index. The index has an expected return of 15%, and its standard deviation is 22%. a. Suppose Percival puts all his money in a combination of the index fund and Treasury bills. Can he thereby improve his expected rate of return without changing the risk of his portfolio?
b. Could Percival do even better by investing equal amounts in the corporate bond portfolio and the index fund? The correlation between the bond portfolio and the index fund is +0.1.