An investor is uncertain about how much to invest in two risky assets. The first asset (equity) yields an expected return of 12% and has a standard deviation equal to 8%. The second asset (debt) yields an expected return of 6% and has a standard deviation of 5%. The correlation coefficient between the returns is -0.1.

1. Compute the expected return and standard deviation of the following portfolios:

1. Sketch the set of portfolios composed of debt and equity in the mean-standard deviation space and identify portfolios 1, 2 and 3.
2. Would a rational risk-averse investor ever choose a portfolio entirely composed of debt? Would a rational risk-averse investor ever choose a portfolio entirely composed of equity?