An investor holding a certain portfolio consisting of two stocks invests 20% in Stock A and...

An investor holding a certain portfolio consisting of two stocks invests 20% in Stock A and 80% in Stock B. The expected return from Stock A is 4% and that from Stock B is 12%. The standard deviations are 8% and 10% for Stocks A and B respectively. Compute the expected return of the portfolio. b) Compute the standard deviation of the portfolio assuming the correlation between the two stocks is 0.75. c) Compute the standard deviation of the portfolio assuming the correlation between the two stocks is 1. d) Compare your answers in (b) and (c). What do you observe and why?

Solutions

Expert Solution

Solution:

Compute the expected return of the portfolio.

Answer: The expected return of the portfolio is:

b) Compute the standard deviation of the portfolio assuming the correlation between the two stocks is 0.75.

Answer:

c) Compute the standard deviation of the portfolio assuming the correlation between the two stocks is 1

Answer:

d) d) Compare your answers in (b) and (c). What do you observe and why?

We see the standard deviation of the portfolio in part b is lesser than the standard deviation of the portfolio in part c. The reason for this is that the correlation coefficient in part b is less than the correlation coefficient in part c. We know that as the correlation coefficient increases the standard deviation of the portfolio also increases.

milcah answered 7 months ago

Next > < Previous

Related Solutions

You are considering investing in two common stocks holding them in a two-stock portfolio. Stock A...

You are considering investing in two common stocks holding them in a two-stock portfolio. Stock A has an expected return of 10% and a standard deviation of 11.2%. Stock B has an expected return of 16% and a standard deviation of 41.1%. if you invest 34% of your portfolio in Stock A and 66% in Stock B and if the correlation between the two stocks is 0.57, what is the portfolio's expected return and standard deviation? A. 13.96% and 19.93%...

Suppose you have a portfolio consisting of two stocks, Stock S and Stock T. $4,000 is...

Suppose you have a portfolio consisting of two stocks, Stock S and Stock T. $4,000 is invested in Stock S and $6,000 is invested in Stock T: State Probability Stock S Stock T Boom 0.10 21% 35% Normal ? 6% 11% Recession 0.60 -17% -40% What is the standard deviation of Stock S? 0.195194 0.186379 0.168237 0.142076 0.137335 What is the portfolio variance? 0.117452 0.093821 0.051505 0.043497 0.038826

An investor can design a risky portfolio based on two stocks, A and B. Stock A...

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 24% and a standard deviation of return of 31%. Stock B has an expected return of 17% and a standard deviation of return of 26%. The correlation coefficient between the returns of A and B is .5. The risk-free rate of return is 6%. The proportion of the optimal risky portfolio that should be invested in stock B is...

An investor can design a risky portfolio based on two stocks, A and B. Stock A...

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 24% and a standard deviation of return of 35%. Stock B has an expected return of 13% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is .5. The risk-free rate of return is 6%. The proportion of the optimal risky portfolio that should be invested in stock B is...

An investor can design a risky portfolio based on two stocks, A and B. Stock A...

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 26% and a standard deviation of return of 39%. Stock B has an expected return of 15% and a standard deviation of return of 25%. The correlation coefficient between the returns of A and B is .5. The risk-free rate of return is 6%. The proportion of the optimal risky portfolio that should be invested in stock B is...

An investor can design a risky portfolio based on two stocks, A and B. Stock A...

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 15% and a standard deviation of return of 25%. Stock B has an expected return of 12% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is 0.2. The risk-free rate of return is 1.5%. A.)Approximately what is the proportion of the optimal risky portfolio that should be invested in...

An investor can design a risky portfolio based on two stocks, A and B. Stock A...

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 14% and a standard deviation of return of 20%. Stock B has an expected return of 21% and a standard deviation of return of 39%. The correlation coefficient between the returns of A and B is .4. The risk-free rate of return is 5%. Would the proportion of the optimal risky portfolio that should be invested in stock A...

An investor can design a risky portfolio based on two stocks, A and B. Stock A...

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 15% and a standard deviation of return of 25%. Stock B has an expected return of 12% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is 0.2. The risk-free rate of return is 1.5%. 1) Approximately what is the proportion of the optimal risky portfolio that should be invested...

An investor can design a risky portfolio based on two stocks, A and B. Stock A...

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 11% and a standard deviation of return of 18.0%. Stock B has an expected return of 7% and a standard deviation of return of 3%. The correlation coefficient between the returns of A and B is 0.50. The risk-free rate of return is 5% Find the proportion of the optimal risky portfolio that should be invested in stock A....

An investor can design a risky portfolio based on two stocks, A and B. Stock A...

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is 0.4. The risk-free rate of return is 5%. 1.Approximately what is the proportion of the optimal risky portfolio that should be invested in...

Subjects