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Stocks A and B have expected returns of 8% and 10%, and standard deviations of 12%...

Stocks A and B have expected returns of 8% and 10%, and standard deviations of 12% and 18%, respectively. Calculate the expected return and standard deviation of equally weighted portfolios of the two stocks if the correlation between the two stocks is 0.5? Repeat the calculation for correlation of 0 and ?0.5. If you could set the correlation between the two stocks, which of the three values would you choose? Explain.

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Answer #1

portfolio standard deviation can be calculated using:

as per the analysis, we'd select the portfolio with -0.5 correlation to get maximum benefit of diversification as with -0.5 correlation, we have minimum standard devation.

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