Consider the following information on two stocks: State of the Economy Probabili

Question

Consider the following information on two stocks:

State of the Economy

Probability of State of Economy

Stock 1

Rate of Return

Stock 2

Rate of Return

Boom

.35

.12

-.28

Normal

.5

.4

.09

Bust

.15

.53

.48

If you have a portfolio that is made up of 50% of stock 1 and 50% of stock 2, what is the portfolio expected return, variance and standard deviation?

State of the Economy

Probability of State of Economy

Stock 1

Rate of Return

Stock 2

Rate of Return

Boom

.35

.12

-.28

Normal

.5

.4

.09

Bust

.15

.53

.48

Explanation / Answer

Expected return variance probability Stock 1 Stock 2 Stock 1 Stock 2 Stock 1 Stock 2 Stock 1 Stock 2 Boom 0.350 0.120 -0.280 0.042 -0.098 0.065 0.104 0.004 0.011 Normal 0.500 0.400 0.090 0.200 0.045 -0.093 -0.039 0.009 0.001 Bust 0.150 0.530 0.480 0.080 0.072 0.028 -0.066 0.001 0.004 0.322 0.019 0.014 0.017 Weights 0.500 0.500 0.500 0.500 0.161 0.009 0.007 0.008 portfolio expected return 0.170 (.16075+.0095) portfolio variance 0.015 (.006815+.008346) portfolio Standard deviaiton 0.123 SQRT of .015161

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