Question

Now let's consider the portfolio, P, of which 75% invested in B and the rest in S. Portfolio P's expected return is 9.725% which is the weighted average of 8.8% (= Er_B) and 12.5% (= Er_S). It is closer to 8.8% than to 12.5% because 75% is invested in B. How about the standard deviation of the portfolio? Is it between ?_B = 8.68%and?_S = 17.5%. The standard deviation of S is17.5% and B is 8.68%.

wB     wS      E(rP)     ?P

1.00   0.00 8.8     8.68

0.75   0.25 9.725   6.06

0       1.00     12.5   17.5

In the above example, the standard deviation of the portfolio's return is lower than that of these two funds B and S. What is the intuition behind this? Is it always the case? Examine how the returns on these two funds behave. Do they move together or in opposite directions?

Answer 1

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