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408:
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ORPORATE
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ROBLEM SET
#4:
P
ORTFOLIO
T
HEORY
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ROF
.
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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 welldiversified
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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 Fall '08
 Croce
 Standard Deviation, Capital Asset Pricing Model, Corporate Finance, Modern portfolio theory

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