The expected return of NW is 15% with a 10% standard deviation of return. The expected return of SE is 8% with a 20% standard deviation of return. Draw the opportunity sets given below by hand on a sheet of paper, overlaying both opportunity sets on the same axes. The y-axis is expected return, and the x-axis is standard deviation.
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Set 1: Correlation between NW and SE is 1.0. Weights in NW vary from 0.50 to 1.50.
Set 2: Correlation between NW and SE is 0.3. Weights in SE vary from 0 to 1.50.
CAse 1
When Correlation between NW and SE is 1.0
As we Know that the expected Return of two securities portfolio is = ERP= ERx*Weightx + ERy*Weighty
And Standard Deviation of two securities portfolio =SDx2* weightx+ SDy2 * weighty + 2*SDx*SDy*Weightx*Weighty* Correlationxy
Hence ERxy SDxy having different weights of NW from 0.5 to 1.5
If Weight of NW | 0.5 | 1.0 | 1.5 |
SE = 1- Weight of NW | 0.5 | 0.0 | -0.5 |
ER |
15*0.5+8*0.5 = 11.5 |
15 | 18.5 |
SD |
102*0.5+202*0.5+2*10*20*0.5*0.5*1 =18.71 |
10 | -14.14 |
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