Jamie Wong is considering building an investment portfolio containing two stocks
ID: 2759272 • Letter: J
Question
Jamie Wong is considering building an investment portfolio containing two stocks, L and M. Stock L will represent 50% of the dollar value of the portfolio, and stock M will account for the other 50%. The expected returns over the next 6 years, 2015 - 2020, for each of these stocks are shown in the following table:. Calculate the expected portfolio return, r_p, for each of the 6 years. Calculate the expected value of portfolio returns, r bar-p, over the 6-year period. Calculate the standard deviation of expected portfolio returns, sigma_r_p, over the 6-year period. How would you characterize the correlation of returns of the two stocks L and M Discuss any benefits of diversification achieved by Jamie through creation of the portfolio.Explanation / Answer
A Year Stock L Stock M 50% of L 50% of M Return 2015 14% 24% 7.00% 12.00% 19.00% 2016 15% 24% 7.50% 12.00% 19.50% 2017 16% 24% 8.00% 12.00% 20.00% 2018 18% 24% 9.00% 12.00% 21.00% 2019 19% 24% 9.50% 12.00% 21.50% 2020 19% 24% 9.50% 12.00% 21.50% B Mean 20.42% C Year Return (Return - Mean return)^2 2015 19% 0.000200694 2016 20% 8.40278E-05 2017 20% 1.73611E-05 2018 21% 3.40278E-05 2019 22% 0.000117361 2020 22% 0.000117361 SD 0.975% D Correlation There is no coerelation between the 2 stocks as you can see irrespective of return of stock L the return of stock M is constant E There are no diversification benefits due to this portfolio as stock M has constant returns Jamie must select a stock which have negative correlation to achieve higher diversification benefits.
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