Question

Mary Guilott recently graduated from Nichols State University and is anxious to begin investing her meager savings as a way of applying what she has learned in business school.​ Specifically, she is evaluating an investment in a portfolio comprised of two​ firms' common stock. She has collected the following information about the common stock of Firm A and Firm​ B: CHART BELOW

a. If Mary invests half her money in each of the two common​ stocks, what is the​ portfolio's expected rate of return and standard deviation in portfolio​ return?

b. Answer part a where the correlation between the two common stock investments is equal to zero.

c. Answer part a where the correlation between the two common stock investments is equal to +1.

d. Answer part a where the correlation between the two common stock investments is equal to −1.

e. Using your responses to questions a—d​, describe the relationship between the correlation and the risk and return of the portfolio.

Expected           Return		Standard Deviation
Firm​ A's common stock	0.15	0.19
Firm​ B's common stock	0.18	0.26
Correlation coefficient	0.70

Answer 1

a)
1.
=0.5*0.15+0.5*0.18=16.50%

2.
=SQRT((0.5*0.19)^2+(0.5*0.26)^2+2*0.5*0.19*0.5*0.26*0.7)=20.7882178168308%

b)
1.
=0.5*0.15+0.5*0.18=16.50%

2.
=SQRT((0.5*0.19)^2+(0.5*0.26)^2+2*0.5*0.19*0.5*0.26*0)=16.101%

c)
1.
=0.5*0.15+0.5*0.18=16.50%

2.
=SQRT((0.5*0.19)^2+(0.5*0.26)^2+2*0.5*0.19*0.5*0.26*1)=22.500%

d)
1.
=0.5*0.15+0.5*0.18=16.50%

2.
=SQRT((0.5*0.19)^2+(0.5*0.26)^2+2*0.5*0.19*0.5*0.26*(-1))=3.500%

e)

Expected returns is independent of correlation

As correlation decrease, standard deviation decreases