Question
In: Math
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 1 year agoRelated Solutions
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Suppose you have a portfolio consisting of two stocks, Stock S and Stock T. $4,000 is...
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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%
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0.195194
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0.142076
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0.043497
0.038826
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