An investor holds a portfolio of two stocks. She puts 70% of her money in Stock

Question

An investor holds a portfolio of two stocks. She puts 70% of her money in Stock A and 30% in Stock B. Stock A has a return RA with mean 8% and a standard deviation of A=4%. Stock B has a return of RB with mean 16% and a standard deviation of B=12%. The portfolio return is Y=0.7 RA + 0.3 RB.

a.Compute the expected return on the portfolio.

b.Compute the standard deviation of the returns on the portfolio assuming that the two stocks’ returns are perfectly positively correlated.

c.Compute the standard deviation of returns on the portfolio assuming that the two stocks’ returns have a zero correlation.

d.Assuming the two stocks' returns have zero correlation (as in part c) and are normally distributed, what is the probability that the portfolio return is negative?

Explanation / Answer

a)

expected return

= 0.7 * 8% + 0.3 * 16%

= 10.4%

b)

standard deviation

= sqrt( 0.04^2 + 0.12^2 + 2 * 0.04 * 0.12)

= 16%

c)

standard deviation = sqrt(0.04^2 + 0.12^2 )

= 0.1265

= 12.65%

d)

P(X <0) = P(Z < 0 - 10.4% /12.65%)

= P(Z < -0.8221)

= 20.55%

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.