Question

# An investor can design a risky portfolio based on two stocks, 1 and 2. Stock 1...

An investor can design a risky portfolio based on two stocks, 1 and 2. Stock 1 has an expected return of 15% and a standard deviation of return of 25%. Stock 2 has an expected return of 12% and a standard deviation of return of 20%. The correlation coefficient between the returns of 1 and 2 is 0.2. The risk-free rate of return is 1.5%.

Approximately what is the proportion of the optimal risky portfolio that should be invested in Stock 2?

WEIGHT OF STOCK 2 = 0.55

 EXPECTED RETURN A 15% EXPECTED RETURN B 12% SD OF STOCK A 25% SD OF STOCK B 20% CORELATION 0.2 VARIANCE OF STOCK A (SDa^2) 0.06 VARIANCE OF STOCK B (SDb^2) 0.04 COVARIANCE A&B (COVab) -0.050 OPTIMAL RISKY PORTFOLIO ((SDb^2)-COV(ab))/((SDa^2)+(SDb^2)-2xCOV(ab)) PORTFOLIO INVESTED IN A (Wa) 0.45 PORTFOLIO INVESTED IN B (Wb) 0.55

NOTE -COVARIANCE A&B IS NEGATIVE TO AN OPPOSITE EFFECT TO STANDARD DEVIATION

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