In: Finance
Refer to the table below:
3 Doors, Inc. | Down Co. | |||||
Expected return, E(R) | 12 | % | 10% | |||
Standard deviation, σ | 41 | 29 | ||||
Correlation | 0.2 | |||||
Using the information provided on the two stocks in the table above, find the expected return on the minimum variance portfolio. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)
Let us denote Doors Inc by “X” and Down Co. by “Y”.
Covariance (X, Y) = Correlation * σX * σY
= 0.2 * 41 * 29
= 237.80 %2
In a minimum Variance Portfolio,
Weight of X = {σY2 - Covariance (X, Y)} / {σX2 + σY2 - 2 *Covariance (X, Y)}
={ 292 – 237.80 } / { 412 + 292 – 2 * 237.80}
= 603.2 / 2046.4
= 0.29
Weight of Y = 1 – 0.29 = 0.71
expected return on the minimum variance portfolio
= 0.29 * 12 + 0.71 * 10
=10.58 %