Problem 1 (20 marks). Stocks offer an expected rate of return of 18%, with a sta

Question

Problem 1 (20 marks). Stocks offer an expected rate of return of 18%, with a standard deviation of 22%. Gold offers an expected return of 10% with a standard deviation of 30%. a) In light of the apparent inferiority of gold with respect to both mean return and volatility, would anyone hold gold? If so, demonstrate graphically why one would do 10 marks b) Given the data above, reanswer a) with the additional assumption that the correlation coefficient between gold and stocks equals 1. Draw a graph illustrating why one would or would not hold gold in one's portfolio. Could this set of assumptions for expected returns, standard deviations, and correlation represent an equilibrium for the security 10 marks] so. market?

Explanation / Answer

Investor desire to invest in where he could get high rate of return with lesser risk

Standard deviation is the measure of risk, higher the standard deviation higher is the risk.

looking to the case above

Gold offers less return as well as more risk as compared to stock, hence all will prefer stock over gold with the profit motive.

As in case b it is assumed that correlation between stock and gold is 1 which represent an equilibrium for the security market.

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