Question

The expected returns, standard deviations and correlation between Xerox (XRX) and Yahoo! (YHOO) are shown below:

			r
	E(r)	s	XRX	YHOO
XRX	11%	20%	1	0.3
YHOO	15%	35%		1

Draw the combination line for portfolios of these two stocks.

Answer 1

	XRX=Asset1 YAHOO=Asset 2
	Return of asset1=R1=	11.00%
	Return of asset2=R2=	15.00%
	Standard Deviation of asset1=S1	20.00%
	Standard Deviation of asset2=S2	35.00%
	Variance of asset 1=V1	400	(20^2)
	Variance of asset 2=V2	1225	(35^2)
	Covariance of asset1,2=Correlation(1,2)*(S1*S2)
	Covariance of asset 1 and 2=Cov(1,2)=	210	0.3*(20*35)
	w1=Investment in asset 1
	w2=Investment in asset 2
	Portfolio Return=Rp
	w1*R1+w2*R2=			……..Equation (1)
	Rp=11w1+15w2…….Equation(1)
	Portfolio Variance=(w1^2)*V1+(w2^2)*V2+2*w1*w2*Cov(1,2)
	Portfolio Variance=(w1^2)*400+(w2^2)*1225+2*w1*w2*210
	Portfolio Variance=(w1^2)*400+(w2^2)*1225+w1*w2*420……………Equation (2)
	Portfolio Standard Deviation=Square root of Variance
(b)	ALL POSSIBLE PORTFOLIOS
		w1	w2	Rp=w1*11+w2*15	Vp(Using Equation (2)	Sp=Square root of Vp
		Weight of	Weight of	Portfolio	Portfolio	Portfolio
		True Valu	The Best	Return(%)	Variance	Std. Deviation(%)
		0.00	1.00	15	1225	35.00
		0.05	0.95	14.8	1126.51	33.56
		0.10	0.90	14.6	1034.05	32.16
		0.15	0.85	14.4	947.613	30.78
		0.20	0.80	14.2	867.2	29.45
		0.25	0.75	14	792.813	28.16
		0.30	0.70	13.8	724.45	26.92
		0.35	0.65	13.6	662.113	25.73
		0.40	0.60	13.4	605.8	24.61
		0.45	0.55	13.2	555.513	23.57
		0.50	0.50	13	511.25	22.61
		0.55	0.45	12.8	473.013	21.75
		0.60	0.40	12.6	440.8	21.00
		0.65	0.35	12.4	414.613	20.36
		0.70	0.30	12.2	394.45	19.86
		0.75	0.25	12	380.313	19.50
		0.80	0.20	11.8	372.2	19.29
		0.85	0.15	11.6	370.113	19.24
		0.90	0.10	11.4	374.05	19.34
		0.95	0.05	11.2	384.013	19.60
		1	0.00	11	400	20.00