Question

benefits of diversification. Sally Rogers has decided to invest her wealth equally across the following three Assets. what are her expected returns and the risk from her investment in the three Assets? how do they compare with investing in asset M alone? hint: find the standard deviations of asset M and of the portfolio equally invested in Assets M,N,O.

states.     probability Asset M,   Assets N,   Asset O
boom.          35%            14%         24%              6%
Normal.       49%            12%         16%            12%
recession.   16%              6%            4%           14%

what is the expected return of investing equally in all three M, N, O?

Answer 1

Ans 12.95%

STATE	PROBABILITY (I)	ASSET M (II)	ASSET M RETURN (I)* (II)	ASSET N (III)	ASSET N RETURN (I)* (III)	ASSET O (IV)	ASSET 0 RETURN (I)* (IV)
BOOM	35%	14%	4.90%	24%	8.40%	6%	2.10%
NORMAL	49%	12%	5.88%	16%	7.84%	12%	5.88%
RECESSION	16%	6%	0.96%	4%	0.64%	14%	2.24%
		TOTAL	11.74%	TOTAL	16.88%	TOTAL	10.22%
expected return of investing equally in all three M, N, O				11.74% * 1/3 + 16.88% * 1/3 + 10.22% * 1/3
				12.95%