Question

. You have $100,000 to invest. You put $40,000 into stock A and the rest into stock B. The

expected returns of stock A and stock B are 10.9% and 13.4%, respectively. The standard
deviations of stock A and stock B are 8.5% and 11%, respectively. If the correlation between
these two stocks’ returns is 0.27, what are the expected return and risk of your portfolio?

Answer 1

The expected return of the portfolio is 11.39% and the risk (standard deviation) of the portfolio is 9.51%.

Step-by-step explanation:

To find the expected return and risk of the portfolio, we need to calculate the weighted average of the expected returns and the standard deviations of the individual stocks.

Expected return of the portfolio = (Weight of stock A * Expected return of stock A) + (Weight of stock B * Expected return of stock B)
Weight of stock A = $40,000 / ($100,000)

= 0.40
Weight of stock B = ($100,000 - $40,000) / ($100,000)

= 0.60
Expected return of the portfolio = (0.40 * 10.9%) + (0.60 * 13.4%)

= 11.39%

Risk of the portfolio (standard deviation) = sqrt((Weight of stock A * Standard deviation of stock A)^2 + (Weight of stock B * Standard deviation of stock B)^2 + (2 * Weight of stock A * Weight of stock B * Standard deviation of stock A * Standard deviation of stock B * Correlation))
Risk of the portfolio = sqrt((0.40 * 8.5%)^2 + (0.60 * 11%)^2 + (2 * 0.40 * 0.60 * 8.5% * 11% * 0.27)) = 9.51%