Question

You can form a portfolio of two assets, A and B, whose returns have the following characteristics:

	Expected Return	Standard Deviation	Correlation
A	6%	19%
			.4
B	18	41

a. If you demand an expected return of 15%, what are the portfolio weights? (Do not round intermediate calculations. Round your answers to 3 decimal places.)

Stock	Portfolio Weight
A
B

b. What is the portfolio’s standard deviation? (Use decimals, not percents, in your calculations. Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Standard deviation             %

Answer 1

1. Let weight of A = w
Weight of B = 1-w
Expected Return = w*6% +(1-w)*18% = 15%
18% -15% = (18%-6%)w
w = 0.25
So weight of A = 0.250
Weight of B = 0.750

2. Portfolio Standard Deviation = ((w* Standard Deviation of A)² +( (1-w)* Standard Deviation of B)² + 2*w*(1-w) * Standard Deviation of A * Standard Deviation of B* Correlation ))^0.5 = ((0.25*19%)² +(0.75%*41%)² + 2*0.25*0.75*19%*41%*0.4)^0.5 = 32.94%

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