Question

In: Finance

Someone holds X stock (ABCD.JK). To minimize the risk, he wants to add another stock, He...

Someone holds X stock (ABCD.JK). To minimize the risk, he wants to add another stock, He is considering to add Y (EFGH.JK) or Z (PQRS.JK). He gathers some information to help him make a decision:

	EFGH.JK	PQRS.JK
Beta	1.25	0.79
Standard Deviation	0.16	0.28
Correlation with ABCD.JK	0.555	0.155
Return	5.1%	18%

The standard deviation of ABCD.JK is 0.1 and the return of ABCD.JK is 4%. The investor wants to build an equality weighted portfolio (both 50% weight). To help him decide, please calculate:

a. The portfolio’s expected return of ABCD.JK and EFGH.JK

b. The portfolio’s expected return between ABCD.JK and PQRS.JK

c. The portfolio’s standard deviation between ABCD.JK and EFGH.JK

D. The portfolio’s standard deviation between ABCD.JK and PQRS.JK

e. Which stock should he add? DEFG.JK or PQRS.JK? Explain!

Expert Solution

	Expected return	Investment Proportion	Standard Deviation	Correlation with ABCD.JK
ABCD.JK	4.00%	50%	0.10
EFGH.JK	5.10%	50%	0.16	0.555
Total		100%
Expected return of portfolio	4.55%
Standard deviation of portfolio	0.1155
return per unit of risk	0.3939

	Expected return	Investment Proportion	Standard Deviation	Correlation with ABCD.JK
ABCD.JK	4.00%	50%	0.10
PQRS.JK	18.00%	50%	0.28	0.155
Total		100%
Expected return of portfolio	11.00%
Standard deviation of portfolio	0.1558
return per unit of risk	0.7061

The portfolio’s expected return of ABCD.JK and EFGH.JK

4.55%

The portfolio’s expected return between ABCD.JK and PQRS.JK

11.00%

c. The portfolio’s standard deviation between ABCD.JK and EFGH.JK

0.1155

D. The portfolio’s standard deviation between ABCD.JK and PQRS.JK

0.1558

e. Which stock should he add? EFGH.JK or PQRS.JK? Explain!

Stock should be added is PQRS.JK because portfolio with this stock has higher return and return per unit of risk is lower for this combination.

Formulas used in excel:

jeff jeffy answered 4 months ago

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