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In: Finance

Assume that your cousin holds just one stock, Eastman Chemical Bonding (ECB), which he thinks has...

Assume that your cousin holds just one stock, Eastman Chemical Bonding (ECB), which he thinks has very little risk. You agree that the stock is relatively safe, but you want to demonstrate that his risk would be even lower if he were more diversified. You obtain the following returns data for Wilder's Creations and Buildings (WCB). Both companies have had less variability than most other stocks over the past 5 years. Using the standard deviation of returns, by how much would your cousin's risk have been reduced if he had held a portfolio consisting of 70% in ECB and the remainder in WCB?

Year

ECB

WCB

2007

40.00%

40.00%

2008

-10.00%

15.00%

2009

35.00%

-5.00%

2010

-5.00%

-10.00%

2011

15.00%

35.00%

*Show your computations and/or excel functions you used in your solution.

Solutions

Expert Solution

Expected return of portfolio = Weight of ECB * return of ECB + Weight of WCB * return of WCB

the Standard deviation of ECB = 22.64% but when we diversify by investing 70% in ECB and 30% in WCB then the Standard Deviation will be 19.32%. by diversifying the risk will be reduced by 3.32% (22.64%-19.32%)

jeff jeffy answered 1 year ago
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