Question

In: Finance

You have a portfolio with a standard deviation of 26% and an expected return of 19%....

You have a portfolio with a standard deviation of 26% and an expected return of 19%. You are considering adding one of the two shares in the table below. If after adding the shares you will have 20% of your money in the new shares and 80% of your money in your existing portfolio, which one should you add?

Expected

return

Standard

deviation

Correlation with

your portfolio's returns

Share A

13%

25%

0.4

Share B

13%

17%

0.5

Standard deviation of the portfolio with share A is .................. %. (Round to two decimal places.)

Standard deviation of the portfolio with share B is .................. %. (Round to two decimal places.)

Which share should you add and why? (Select the best choice below.)

A. Add A since the portfolio is less risky when A is added.

B. Add B because the portfolio is less risky when B is added.

Expert Solution

Standard Deviation of the portfolio with Share A:

Formula:

where,

Xa= Weight in Portfolio = 80%

Xb= Weight in Share A = 20%

a= Standard deviation in portfolio= 26%

b= Standard deviation in Share A= 25%

Pab= Correlation with portfolio's returns= 0.4

=

Ans = 23.26%

Standard Deviation of the portfolio with Share B:

where,

Xa= Weight in Portfolio = 80%

Xb= Weight in Share B = 20%

a= Standard deviation in portfolio= 26%

b= Standard deviation in Share B= 17%

Pab= Correlation with portfolio's returns= 0.5

=

Ans = 22.69%

Comment:

Standard Deviation of the portfolio with Share A = 23.26%

Standard Deviation of the portfolio with Share B = 22.69%

Add Share B, since the standard deviation of the portfolio is less risky when share B is added.

jeff jeffy answered 2 years ago

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