Suppose you purchased $1,000 of Stock A with your own money. You then borrowed $

Question

Suppose you purchased $1,000 of Stock A with your own money. You then borrowed $500 and used this money to buy Stock B. This means that the portfolio weights are as follows: wA = 1000/1000 = 1.00; wB = 500/1000 = 0.50; wC = -500/1000 = - 0.50. The correlation coefficient between A and B is 0.70; interest rate on the risk-free asset (Security C) is 5%; variance of Stock A is 0.25; variance of Stock B is 0.49; expected return on Stock A is 10% and Stock B is 16%. Calculate the expected return of the portfolio comprising securities A, B, C.

a. 13.5% b. 14.5% c. 15.5% d. None of the above

Calculate the variance of a portfolio of the three securities.

a. 0.6175 b. 0.7858 c. 0.5168 d. None of the above

Explanation / Answer

Answer to the Question

Portfolio return=R(A)*W(A)+R(B)*W(B)+R(C)*W(C)

=(10%*1)+(16%*0.5)+(5%*-0.5)

=15.5%.

Option C is correct.

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