Stocks A, B, and C all have an expected return of 10% and a standard deviation o

Question

Stocks A, B, and C all have an expected return of 10% and a standard deviation of 25%. Stocks A and B have returns that are independent of one another, i.e., their correlation coefficient, r, equals zero. Stocks A and C have returns that are negatively correlated with one another, i.e., r is less than 0. Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B. Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C. Which of the following statements is CORRECT?

A.) Portfolio AC has an expected return that is less than 10%.

B.) Portfolio AC has an expected return that is greater than 25%.

C.) Portfolio AB has a standard deviation that is greater than 25%.

D.) Portfolio AB has a standard deviation that is equal to 25%.

E.) Portfolio AC has a standard deviation that is less than 25%.

Explanation / Answer

Stocks A, B, and C all have an expected return of 10% and a standard deviation of 25%. Stocks A and B have returns that are independent of one another, i.e., their correlation coefficient, r, equals zero. Stocks A and C have returns that are negatively correlated with one another, i.e., r is less than 0. Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B. Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C. Which of the following statements is CORRECT?

answer is

E.) Portfolio AC has a standard deviation that is less than 25%.

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