Ch8nClassProblems

# Ch8nClassProblems - You own a portfolio of 2 stocks...

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You own a portfolio of 2 stocks, E(R a )=10%, σ a =20%; E(R b )=15%, σ b =25% and ρ ab =-1 Which of the following is most correct? Portfolio return is 12.5% Portfolio variance is 22.5% It will be to your advantage to have as much of stock B in your portfolio as possible since that will increase portfolio return. While ρ =-1 reduces risk, it would be better to have ρ =0. It is possible to create a portfolio of A and B with zero risk. Answer a is correct only when the portfolio weights are .5 for stock A and .5 for stock B. In this case, portfolio return will be .5 x .1 + .5 x .15 = .125 or 12.5%. At any other weights, the portfolio return will not be 12.5%. Since the problem doesn’t specify weights, answer a in incorrect. Answer b is correct only if the portfolio weights are .5/.5 and the correlation coefficient is +1, perfect positive correlation. In this case, the portfolio variance is x 1 2 σ 1 2 + x 2 2 σ 2 2 + 2x 1 x 2 ρ 12 σ 1 σ 2 = .5 2 *.2 2 +.5 2

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Ch8nClassProblems - You own a portfolio of 2 stocks...

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