Analyzing portfolio risk and return involve the understanding of expected return

Question

Analyzing portfolio risk and return involve the understanding of expected returns from a portfolio. Consider the following case: Andre is an amateur investor who holds a small portfolio consisting of only four stocks.The stock holdings in his portfolio are shown in the following table: Artemis (20% of portfolio, 6.00% expected return, 34.00% standard deviation) Babish & Co. (30% of portfolio, 14.00% expected return, 38.00% standard deviation) Cornell Industries (35% of portfolio, 12.00% expected return, 41.00 standard deviation) Danforth Motors (15% of portfolio, 3.00% expected return, 43.00% standard deviation) What is the expected return of Andre's stock portfolio? a. 15.08, b. 13.57, c. 10.05 d. 7.54 Suppose each stock in the preceding portfolio has a correlation coefficient of 0.4 (p=0.4) with each of the other stocks. If the weighted average of the risk (standard deviation) of the individual securities in the partially diversified portfolio of four stocks is 39%, the portfolio's standard deviation most likely is ________ 39%. a. equal to, b. more than, c. less than

Explanation / Answer

1) expected return is 0.2 * 6 + 0.3 * 14 + 0.35 * 12 + 0.15 * 3 = 10.05%

hence c) 10.05%

2) c) less than as the correlation is less than 1. If the correlation is 1, then its equal to. In no case it can be more than 39% as correlation can never be >1

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