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#4 Portfolio Theory


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U NIVERSITY OF N ORTH C AROLINA A T C HAPEL H ILL K ENAN -F LAGLER B USINESS S CHOOL B USI 408: C ORPORATE F INANCE P RACTICE P ROBLEM SET #4: P ORTFOLIO T HEORY P ROF . A RZU O ZOGUZ 1. Consider the following distribution of returns, with ρ AM = 0.38, ρ BM = 0.92: Probability R A R B R M 30% -20% -5% 40% 5% 10% 30% 40% 15% E(R) ? ? 12% σ ? ? 15% a. Fill in the question marks. b. Find the covariance and the correlation between the returns of A and B. c. What is the expected return and standard deviation of a portfolio with 40% in A, 40% in B, and 20% in M? 2. Briefly explain why the covariance of a security with the rest of a well-diversified portfolio is a more appropriate measure of the risk of the security than the security’s variance. 3. A portfolio consists of 120 shares of Atlas stock, which sells for $50 per share, and 150 shares of Babcock stock, which sells for $20 per share. What are the weights of the two stocks in this portfolio? a. Atlas has an expected return of 12 percent, and a standard deviation of 9 percent per year.
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