Campbell's father holds just one stock, East Coast Bank (ECB), which he thinks is a very...

Campbell's father holds just one stock, East Coast Bank (ECB), which he thinks is a very low-risk security. Campbell agrees that the stock is relatively safe, but he wants to demonstrate that his father's risk would be even lower if he were more diversified. Campbell obtained the following returns data shown for West Coast Bank (WCB). Both have had less variability than most other stocks over the past 5 years. Measured by the standard deviation of returns, by how much would his father's historical risk have been reduced if he had held a portfolio consisting of 50% ECB and the remainder in WCB? Enter your answer rounded to two decimal places. Do not enter % in the answer box. For example, if your answer is 0.12345 or 12.345% then enter as 12.35 in the answer box. Year ECB WCB 2014 20.00% 25.00% 2015 -10.00% 15.00% 2016 35.00% -5.00% 2017 -5.00% -10.00% 2018 15.00% 35.00%

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Answer to the Question:

The Risk will be significantly reduced if the portfolio consists of ECB and WCB equally weighted. The SD of the Portfolio is 12.31% from 16.55% of a portfolio consisted of only ECB i.e 4.24%

A B D E F G H I J K L M N O Answer to Part Requried 1 Porfolio Expected Return 2 Portfolio Variance 3 ECB Standard Deviation 4 WCB Standard Deviation 5 Portfolio Standard Deviation 1 Answer Formula 11.50% =(E14*H8)+(F14*H9) 0.02 =((H9^2)*(642)+(H10^2) *H42)+(2*G30*H9*H10) 16.55% =G38 17.20% =G38 12.31% =SQRT(D3) Weight Stock 0.50 ECB 0.50 WCB WCB Calculation of Average Return 2 Years ECB 2,014 2,015 2,106 2,017 2,018 Average Return 20.00% 25.00% -10.00% 15.00% 35.00% 5.00% -5.00% -10.00% 15.00% 35.00% 11.00% 12.00% Calculation of Co-Variance Years 2,014 2,015 2,106 2,017 2,018 3 ECB WCB 20.00% 25.00% -10.00% 15.00% 35.00% 5.00% -5.00% -10.00% 15.00% 35.00% Co-Variance 4 5 6 A-(A) B-BL 5 X6 0.0900 0.1300 0 .0117 -0.2100 0.0300 -0.0063 0.2400 -0.1700 -0.0408 -0.1600 -0.2200 0.0352 0.0400 0.2300 0.0092 0.0018 Calculation of Variance & SD 2 ECB Probability 2,014 2,015 2,106 2,017 2,018 Varaince Standard Deviation 1 3 WCB 20.00% 25.00% -10.00% 15.00% 35.00% 5.00% -5.00% -10.00% 15.00% 35.00% 4 5 6 7 A-(A) B-(B) (A-A)^2 (B-(B)^2 0.0900 0.13001 0.0081 0.0169 -0.2100 0.0300 0.0441 0.0009 0.2400 -0.1700 0.0576 0.0289 -0.1600 -0.2200 0 .0256 0.0484 0.0400 0.2300 0.0016 0.0529 2.74% 2.96% 16.55% 17.20%

jeff jeffy answered 1 year ago

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Campbell's father holds just one stock, East Coast Bank (ECB), which he thinks is a very...

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