You have recently been hired by a wealth management firm and are in charge of designing optimal portfolios for several high-net worth clients. The firm had chosen three ETFs that invest in Domestic Equity (asset A), Foreign Equity (asset B) and Long-Term Bonds (asset C) as well as a Money Market Mutual Fund (asset D) which will serve as the risk-free asset. For these asset classes the research department has provided you with the following assumptions. Asset Class Correlation with Expected Returns Standard Deviation Domestic Equity Foreign Equity Long-Term Bonds
Domestic Equity (A) 9.3% 18.5 %
Foreign Equity (B) 10.77% 20.4% 0.77
Long-Term Bonds (C) 5.2 % 6.8 % 0.37 0.21
Also the Money Market Mutual Fund expected return is 0.5% (your risk free-rate) And you get the tangency portfolio arrangement (portfolio weights and standard deviation):
Tangency:
W(A) -0.05
W(B) 0.20
W(C) 0.85
Sum 1.00
Portfolio Variance 0.0051
Portfolio Standard Deviation 7.14%
Portfolio Expected Return 6.11%
Sharpe Ratio (Target) 0.79
Suppose one of your clients is interested in investing $200 million in a portfolio with an expected return of 12%. What investment would you recommend in each of the asset classes? Give a specific recommendation about what amount your client should invest in the Money Market Mutual Fund, Domestic equities, Foreign equities and Long-Term bonds. What is the standard deviation of the portfolio that you recommend?