2. Standard deviation of the portfolio with stock B is ____ % 3. Which stock wou

Question

2. Standard deviation of the portfolio with stock B is ____ %

3. Which stock would you add and why?

a. Add B because the portfolio is less risky when B is added.

b. Add A because the portfolio is less risky when A is added.

c. Add either one because both portfolios are equally risky.

You have a portfolio with a standard deviation of 27% and an expected return of 19%. You are considering adding one of the two stocks in the following table. If after adding the stock you will have 25% of your money in the new stock and 75% of your money in your existing portfolio, which one should you add? Standard deviation of the portfolio with stock A is (Round to two decimal places.)

Explanation / Answer

3. The answer should be "b." The weighted return of the portfolio remains the same at 18% while the standard deviation by adding stock A is lower than by adding stock B indicating lower risk.

Standard Deviation Expected Return Correlation with portfolio Weight Existing portfolio 27% 19% 0.75 Stock A 24% 15% 0.3 0.25 Stock B 17% 15% 0.7 0.25 Weighted average return of the portfolio with stock A =15%x0.25+19%x0.75 = 18.0% 1. Standard deviation with Stock A =[27%2x0.752+24%2x0.252 + 2x0.75x0.25x0.3x27%x24%]1/2 = 22.78% Weighted average return of the portfolio with stock B =15%x0.25+19%x0.75 = 18.0% 2. Standard deviation with Stock B =[27%2x0.752+17%2x0.252 + 2x0.75x0.25x0.7x27%x17%]1/2 = 23.42%

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