Question

Mrs Lily Flower is investing both in domestic stocks denominated in euro (EUR) and the stocks of the Switzerreich stock market, denominated in Switzerreich Urban Rupel (SUR). Compute the volatility in per cent for Mrs Flower's portfolio, given that she invests 52,3 per cent of her wealth in domestic stocks, having a volatility of 20 per cent, and the rest in the Switzerreich stock market, having a volatility of 21,8 per cent. The volatility of the FX rate is 5,8 per cent. Finally, it has been estimated that the correlation between the stock markets is 0,49, between domestic stocks and FX -0,07, and between the foreign stocks and FX 0,12.

Answer 1

The volatility of Mrs. Lily Flower's portfolio is approximately 35.28%.

Step-by-step explanation:

To compute the volatility of Mrs. Lily Flower's portfolio, we can use the formula:

Portfolio Volatility (%) = sqrt((w1^2 * s1^2) + (w2^2 * s2^2) + (2 * w1 * w2 * s1 * s2 * c)),

where:

• w1 and w2 are the weights of domestic and foreign stocks in the portfolio (52.3% and 47.7% respectively),
• s1 and s2 are the volatilities of domestic and foreign stocks (20% and 21.8% respectively),
• c is the correlation between domestic stocks and foreign stocks (0.49 in this case).

Plugging in the values:

• w1 = 0.523, w2 = 0.477, s1 = 0.20, s2 = 0.218, c = 0.49

We get:

• Portfolio Volatility (%) = sqrt((0.523^2 * 0.20^2) + (0.477^2 * 0.218^2) + (2 * 0.523 * 0.477 * 0.20 * 0.218 * 0.49))
• Portfolio Volatility (%) = sqrt(0.0425 + 0.0469 + 0.0352) = sqrt(0.1246) = 0.3528

Therefore, the volatility of Mrs. Lily Flower's portfolio is approximately 0.3528, or 35.28%.