bond spreads

an analyst determines a portfolio with 35% weight in investment a and a 65% weight in investment b will have a standard deviation of returns equal to 0. * investment a has an expected return of 8% * investment b has a standard deviation of returns of 7.1% and a covariance with the market of 0.0029 * the risk-free rate is 5% and the market risk premium is 7% if no arb opportunities are available, the expected rate of return on the combined port is closest to: a. 5% b. 6% c. 7%

Forget all the crap in the question. If no arbitrage opportunities are available, the return must equal the risk free rate. The correct answer is A. You’re welcome :slight_smile: BTW what does this question have to do with ‘bond spreads’?

that was the explanation given in the answer key, but I wanted to see how to calculate the answer out.

You can’t calculate the answer. All that information is just provided to make you scratch your head until you’re bald.

I think the standard deviation being 0 makes the return have to equal 5%… But even if there are no arb opportunities, there is still the possibility of earning a return above the risk free rate by taking on more risk (more positive standard deviation).