Consider the following information for three stocks, A, B, and C. The stocks\' r

Question

Consider the following information for three stocks, A, B, and C. The stocks' returns are positively but not perfectly positively correlated with one another, i.e., the correlations are all between 0 and 1. Expected Standard Stock Return Deviation Beta A 10% 20% 1.0 B 10% 10% 1.0 C 12% 12% 1.4 Portfolio AB has half of its funds invested in Stock A and half in Stock B. Portfolio ABC has one third of its funds invested in each of the three stocks. The risk-free rate is 5%, and the market is in equilibrium, so required returns equal expected returns. Which of the following statements is CORRECT? Question 13 options: a) Portfolio ABC's expected return is 10.66667%. b) Portfolio AB has a standard deviation of 20%. c)Portfolio ABC has a standard deviation of 20%. d)Portfolio AB's required return is greater than the required return on Stock A. e)Portfolio AB's coefficient of variation is greater than 2.0.

Explanation / Answer

expected return AB = .5*10 + .5*10 = 10%

expected return ABC = (10+10+12)/3 = 10.6667%

maximum s.d od AB (if correl=1) = .5*20+.5*10 = 15%...so s.d 20% not possible

max s.d. on ABC = (20+10+12)/3 = 14%

hence correct ans = a) Portfolio ABC's expected return is 10.66667%.

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