Question

You have been given information about the expected performance of two securities, A and B, over the next year. Assume that the performance of the securities largely follow the performance of the economy. For the particular year, four scenarios of economic performance are expected for each respective security and are as advised below.

Based on this information, you have been requested to undertake a performance analysis with a view to forming a two-security portfolio. The correlation coefficient of the securities returns is 0.35.

A		B
Prob.	Return (%)	Prob.	Return (%)
0.2	-10	0.15	-12
0.3	-5	0.55	11
0.4	10	0.2	18
0.1	25	0.1	25

Required:

Clearly evaluate these securities covering:

• a)The expected returns for the Securities;
• b)The total volatilities in these returns;
• c)Assuming investment proportions for the Stock A of 0% to 100%, in increments of 10%;
  • i)The portfolios that are not feasible.
  • ii)The Minimum Variance Portfolio.
  • iii)The optimum Portfolio.

Answer 1

The expected returns for security A and B are 3% and 10.35% respectively.

The standard deviations for security A and B are 12.38% and 10.41% respectively.