Risk and Return Trade-off

1) Using portfolio theory, explain how investors can choose their optimal portfolios in the presence of one risky and one risk free asset and how preferences affect their decisions.
2) Explain intuitively the assumptions underlying the choice of optimal portfolios in the presence of one risky and one risk free asset. Take the example of one risk averse and one risk-tolerant investor and show graphically the impact of risk aversion on their portfolio selection.
3) Compute monthly holding period returns (HPRs) for the two stocks. (Performance Area 3).
4) Compute the stocks expected return, variance, and standard deviation using historical data. (Performance Area 3).
5) Compute the expected return and standard deviation for the portfolios 1 & 2 by completing the below table. Portfolio 1 contains the risk-free asset and stock 1 whereas portfolio 2 contains the risk-free asset and stock 2. Assume a risk-free rate of 0.25%.