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The expected return on stocks A and B are 20%, and 30%, respectively. The standard deviation...

The expected return on stocks A and B are 20%, and 30%, respectively. The standard deviation of stocks A and B are 20%, and 40%, respectivley. The correlation coefficient between the two stocks is negative one. You plan to form a portfolio from stocks A and B that will yield zero risk. What proportions of your money will you invest in stock A?

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Answer #1

Given that 2 stock are available with following details:

Expected return on stock A Ra = 20%

Standard deviation of stock A SDa = 20%

Expected return on stock B Rb = 30%

Standard deviation of stock B SDb = 40%

Correlation between the stock Corr(a,b) = -1

When correlation between two stock is -1, it is possible to create a risk free portfolio, where weight of stock A is calculated as:

Weight of stock A, Wa = SDb/(Sda+SDb) = 40/(20 + 40) = 0.6667 or 66.67%

So, proportion of money invested in stock A is 66.67%

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