you are given the following information concerning two stocks You are given the

Question

you are given the following information concerning two stocks You are given the following information concerning two stocks: What is the expected return on a portfolio consisting of 40 percent in stock A and 60 percent in stock B? What is the standard deviation of this portfolio? Discuss the risk and return associated with investing (a) all your funds in stock A, (b) all your funds in stock B, and 40 percent in A and 60 percent in B. (This answer must use the numerical information in your answers derived above.)

Explanation / Answer

A./

EXPECTED RETURN OF PORTFOLIO

= (WEIGHT OF STOCK A * EXPECTED RETURN OF STOCK A ) + (WEIGHT OF STOCK A * EXPECTED RETURN OF STOCK A )

= (0.40 * 0.10) + (0.60 * 0.14)

= 0.04 + 0.084

= 0.124 OR 12.4%

B./

STANDARD DEVIATION OF PORTFOLIO

=SQUARE ROOT OF 0.42 * 3.02 + 0.62 * 5.02 + 2 * 0.4 * 3.0 * 0.6 * 5.0 * -0.1

=SQUARE ROOT OF 1.44 + 9 + 7.2 * -1

= SQUARE ROOT OF 17.64

= 4.2%

C./

IF YOU INVEST 100% IN STOCK A THE RETURN WILL BE 10% BUT SIMUNTANIOUSLY YOU HAVE TO BEAR A 3% RISK FOR IT.

IF YOU INVEST 100% IN STOCK B THE RETURN WILL BE 14% BUT SIMUNTANIOUSLY YOU HAVE TO BEAR A 5% RISK FOR IT.

IN CASE OF THE PORTFOLIO IF YOU INVEST 40% IN STOCK A AND 60% IN STOCK B THE THE EXPECTED RETURN YOU WOULD EARN 12.4% BUT FOR THIS RETURN YOU HAVE TO BEAR A RISK OF 4.2%

NOTE-

AS THE CORRELATION COEFFICENT IS NOT CLEAR I;E -1 OR -0.1

I HAVE CALCULATED THE ABOVE FIGURE TAKING THE CORRELATION COFFICIENT AS -1 IF IT IS -0.1 THE STANDARD DEVIATION WILL BE 1.33%

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