Suppose there are two common stocks available for investment, stock A and stock

Question

Suppose there are two common stocks available for investment, stock A and stock B, with the following characteristics: Calculate the portfolio expected return and standard deviation of return for each of the following portfolios: Sketch {this does not have to be a work of art, but try to be careful) the feasible set of all portfolios composed of A and B. Suppose that there is now the opportunity to borrow or lend at the risk-free rate of return, which is 10%. Show on your sketch in part (B) how this changes the investment opportunities available. (Be sure to clearly label this "PART C".) Assume you are a rational investor and can invest in stock A, stock B, the risk-free security, or any combination thereof. Further assume that you have $150,000 and decide to invest $60,000 in the risk-free security and $90,000 in risky securities. Approximately how much money will you invest in Security B? Briefly explain how you arrived at your answer.

Explanation / Answer

(a) Return on portfolio R(p) = RA*WA + RB*WB

S.D. of two assets portfolio = {(S,D.A*WA)2 + (S.D.B*WB)2 + (2*S.D.A*WA*S.D.B*WB*rAB)}1/2

  1. R(p) = 10%*1 + 40%*0

= 10%

S.D.AB = {(30%*1)2 + (20%*0)2 + (2*30%*1*20*0*-0.7)}1/2

  = 30%

2.  R(p) = 10%*2/3 + 40%*1/3

= 20%

S.D.AB = {(30%*2/3)2 + (20%*1/3)2 + (2*30%*2/3*20*1/3*-0.7)}1/2

   = 16.05%

3. R(p) = 10%*1/3 + 40%*2/3

= 30%

S.D.AB = {(30%*1/3)2 + (20%*2/3)2 + (2*30%*1/3*20*2/3*-0.7)}1/2

= 9.55%

4. R(p) = 10%*0 + 40%*1   

= 40%

S.D.AB = {(30%*0)2 + (20%*1)2 + (2*30%*0*20*1*-0.7)}1/2

= 20%

= 9.55%

4. Since desired return or desired risk is not given in the question, thus, it won't be possible to answer the question

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