Question

Consider a portfolio that consists of an equal investment in two firms. For both firms, there is a 10 percent probability that the firms will have a 0% return, and a (1-10) percent probability that they will have a 1% return. The firms' returns are independent of each other.

Find the standard deviation of this portfolio. (Answer in % and round to 2 decimal places)

Answer 1

Answer Since securities are independent the correlation between them will be 0.

so Portfolio standard deviation will be

=

where Wa = Weight of stock a (0.50) ; Wb = Weight of Stock B(0.5); SDa = Standard deviation of stock A (3); SDb = Standard deviation of stock B (3); r = Correlation Coefficient between a & b (0)

= squareroot((0.5*3)^2 + (0.5*3)^2) = 2.12 %

Formula for calculation of Means and Standard Deviation are

Expected Return =∑( Probability * Return ) and Standard Deviation = .

Excel calculation is as follows: