Two Risky and One Risk Free Investment Zoomed

Mike May
This applet looks at building a portfolio from two risky investments, S and B, (for stocks and bonds) and a risk free investment, RF. For each investment we have a rate of return , and a value of risk . We also need to know , the correlation of the risk between the two risky investments. For a given correlation we get a curve connecting S and B giving the possible risk and return of an investment made by combining these investments. If the two risks are perfectly correlated, the curve is a straight like. If the are inversely correlated, the curve is a pair of line segments that meet on the rate of return axis.. We need to decide a weight of the money we put in S vs B, giving a combined investment C. Once we have C we need to weight the investment between C and RF. That gives IP as our combined investment. For an optimal investment strategy, we want to choose the weight between S and B such that the line between RF and C is tangent to the investment curve.