1. Security C has an expected return of 6% and a standard deviation of 3% while

Question

1. Security C has an expected return of 6% and a standard deviation of 3% while security D has an expected return of 10% and a standard deviation of 7%. The correlation of returns between the two securities is –1.

a) If you place half of the money in each stock, then what is the expected return of this portfolio?

b) If you place 20% of the money in stock C and the remaining in stock D, then what is the expected return of the portfolio?

c) What is the portfolio standard deviation in b above?


2. a) A security has a beta of 1.5 when the risk-free rate is 2.6 percent and the expected return on the market is 12 percent. Calculate the expected return on the security.

b) If the beta on the security in a) increases to 2.5, what is the new expected return? Why does the expected return increase as the beta increases?

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Explanation / Answer

Detail Security C Security D Portfolio Expected Return 6% 10% Std Deviation 3% 7% a Weight 0.5 0.5 Return on Portfolio=Weigted Average return on Securities 8% b Weight 0.2 0.8 Return on Portfolio=Weigted Average return on Securitie 9% c Portfolio Risk=Portfolio Std Deviation=(Std Deviation of Security 1^2* Weight of Security 1^2+Std Deviation of Security 2^2*Weight of security 2^2*(2*Weight of Security 1 *Weight of Secrity 2*(Correlation Coefficient*Std Deviation of Security 1*Std Deviation of Security 2)) Portfolio Return 5.00%

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