Question

You have one share of Sierra stock and one share of Tango stock in a portfolio. Both are equally priced. Both have an expected return of 9% and both have a standard deviation of returns of 2%. The returns of the two stocks are not perfectly correlated. Which of the following statements is true about this two-stock portfolio?

	A.	The portfolio expected return is not 9% and the portfolio standard deviation is 2%
	B.	Answer is not listed or is not possible
	C.	The portfolio expected return is 9% and the portfolio standard deviation is 2%
	D.	The portfolio expected return is not 9% and the portfolio standard deviation is not 2%
	E.	The portfolio expected return is 9% and the portfolio standard deviation is not 2%

Answer 1

Correct option is (E)

Explanation:- Expected return of portfolio is weighted average of individual returns .As given in question that both stocks in portfolio has equal weight and same expected return of 9% ,therefore their weighted average will also be 9% and hence expected return of portfolio will be 9%

But standard deviation of portfolio is not weighted average and correlation coefficient is also a factor while calculating standard deviation of portfolio and when stocks are not perfectly correlated then we get the benefit of diversifcation and therefore standard deviation of Portfolio will be less than 2%