Question

Mary Guilott recently graduated from college and is evaluating an investment in two​ companies' common stock. She has collected the following information about the common stock of Firm A and Firm​ B:  CHART BELOW

.a.  If Mary decides to invest 10 percent of her money in Firm​ A's common stock and 90 percent in Firm​ B's common​ stock, what is the expected rate of return and the standard deviation of the portfolio​ return?

b.  If Mary decides to invest 90 percent of her money in Firm​ A's common stock and 10 percent in Firm​ B's common​ stock, what is the expected rate of return and the standard deviation of the portfolio​ return?

c.  Recompute your responses to both questions a and b​, where the correlation between the two​ firms' stock returns is −0.30.

d.  Summarize what your analysis tells you about portfolio risk when combining risky assets in a portfolio.

a.  If Mary decides to invest 10​% of her money in Firm​ A's common stock and 90​% in Firm​ B's common stock and the correlation coefficient between the two stocks is 0.30​, then the expected rate of return in the portfolio is ______​%. ​(Round to two decimal​ places.)

Expected           Returns		Standard Deviation
Firm​ A's common stock	0.15	0.12
Firm​ B's common stock	0.09	0.08
Correlation coefficient	.30

Answer 1

a)
1.
=10%*0.15+90%*0.09=9.60%

2.
=SQRT((10%*0.12)^2+(90%*0.08)^2+2*10%*0.12*90%*0.08*0.3)=7.64617551459552%

b)
1.
=90%*0.15+10%*0.09=14.40%

2.
=SQRT((90%*0.12)^2+(10%*0.08)^2+2*90%*0.12*10%*0.08*0.3)=11.0663453768622%

c)
a)
1.
=10%*0.15+90%*0.09=9.60%

2.
=SQRT((10%*0.12)^2+(90%*0.08)^2+2*10%*0.12*90%*0.08*(-0.3))=6.93512797286395%

b)
1.
=90%*0.15+10%*0.09=14.40%

2.
=SQRT((90%*0.12)^2+(10%*0.08)^2+2*90%*0.12*10%*0.08*(-0.3))=10.5875398464421%

d)

Due to diversification, risk reduces