Expected annual return for Boeing is 13% and for Coca-Cola is 12%. Also, SD(Rba) = 0.26,...

Expected annual return for Boeing is 13% and for Coca-Cola is 12%. Also, SD(Rba) = 0.26, SD(Rko) = 0.16, Corr(Rba, Rco) = 0.34

A. What is the expected return and risk (standard deviation) of your portfolio if you hold only Boeing?

B. If you split your money evenly between Boeing and Coca-Cola, what is the expected return and risk of your portfolio?

Expert Solution

A).

If the portfolio has only one stock, the characteristics of the portfolio will be same as that of the stock.

As the portfolio hold only Boeing, expected return on the portfolio is 13% and risk of portfolio is 0.26

B).

Given that money is split evenly between the two stocks. So, weights of the stocks in the portfolio is 0.5 and 0.5

Expected return on portfolio with 2 stocks can be calculated as (W1*R1)+(W2*R2), where W1 and W2 are weights and R1 and R2 are expected returns. So, Expected return on portfolio= (0.5*13%)+(0.5*12%)= 12.5%

Risk on the portfolio is calculated using the formula, square root of ((W1^2*sd1^2)+(W2^2*sd2^2)+(2*W1*W2*sd1*sd2*correlation)), where sd1 and sd2 are risk of individual stocks. So, Risk on portfolio= square root of ((0.5^2*0.26^2)+(0.5^2*0.16^2)+(2*0.5*0.5*0.26*0.16*0.34))= square root of (0.0169+0.0064+0.007072)= square root of (0.030372)= 0.1743

Expected return on portfolio= 12.5%

Expected risk on portfolio= 0.1743

jeff jeffy answered 1 year ago

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