Final answer:
To calculate the expected return of a portfolio, multiply the expected return of each stock by its weight in the portfolio and sum the results. The expected return of a portfolio is not affected by the correlation between stocks. If the correlation between stocks increases, it will generally increase the standard deviation of the portfolio.
Step-by-step explanation:
b. Find the expected value for each investment.
To find the expected return of a portfolio, we multiply the expected return of each stock by its weight in the portfolio and then sum the results.
The expected return of a portfolio that is equally invested in both stocks can be calculated as:
Expected Return = (Expected Return of Stock J × Weight of Stock J) + (Expected Return of Stock W × Weight of Stock W)
Assuming Stock J has an expected return of X and Stock W has an expected return of Y, and the portfolio is equally invested in both stocks (i.e., the weight of each stock is 0.5), the formula becomes:
Expected Return = (X × 0.5) + (Y × 0.5).
c. If the correlation between the two stocks increases, what happens to the expected return of the portfolio? Does the expected return rise or fall?
The expected return of a portfolio is not affected by the correlation between the two stocks. The expected return is calculated based on the expected return of each stock and the weight of each stock in the portfolio.
d. If the correlation between the two stocks increases, will the standard deviation of the portfolio rise or fall?
The standard deviation of a portfolio depends on the individual standard deviations of the stocks, the weights of the stocks in the portfolio, and the correlation between the stocks. If the correlation between the two stocks increases, it will generally increase the standard deviation of the portfolio. This is because a higher correlation means that the stock prices tend to move together more closely, increasing the overall volatility of the portfolio.