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Unformatted text preview: INVESTMENT ANALYSIS 70-492 Fall 2009 Suggested Solution to Problem Set 2 Let be the proportion of wealth invested in Apple and (1- ) the proportion invested in Banana. The expected return and the standard deviation of the return on a portfolio of the two risky assets is E ( r P ) = E ( r A ) + (1- ) E ( r B ) (1) P = q 2 2 A + (1- ) 2 2 B + 2 (1- ) AB A B (2) a) AB =- . 5. Solve (2) for and substitute the value of into (1) to obtain E ( r P ). This gives = 0 . 252 ,E ( r P ) = 0 . 072. b) AB = 0. = 0 . 291 ,E ( r P ) = 0 . 0697. c) AB = 0 . 5. = 1 ,E ( r P ) = 0 . 02. d) Target standard deviation = 0.05. The expected return that he can obtain for each choice of the correlation coefficient is AB =- . 5 E ( r P ) = 0 . 0723 AB = 0 E ( r P ) = 0 . 0697 AB = 0 . 5 E ( r P ) = 0 . 0663 Hence he chooses AB =- . 5 because that choice gives him the highest expected return (the benefits of diversification are greater when two assets are negatively correlated).benefits of diversification are greater when two assets are negatively correlated)....
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This note was uploaded on 01/20/2012 for the course INVESTMENT 101 taught by Professor Unknown during the Spring '08 term at Carnegie Mellon.
- Spring '08