Question

In: Finance

Refer to the table below: 3 Doors, Inc. Down Co. Expected return, E(R) 12 % 10%...

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.)

Solutions

Expert Solution

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 %


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