2. Suppose you have two risky securities, stock A which has an expected return o

Question

2. Suppose you have two risky securities, stock A which has an expected return of 14% and a variance of 420 and stock B with an expected return of 9% and a variance of 165. The covariance between the two assets is 68. The risk free rate is 6%.

a. Calculate the expected return and the standard deviation for a risky portfolio formed out of stocks A and B with weights of .6 for stock A and .4 for stock B.

b. Calculate the expected return and standard deviation of the complete portfolio if you invest 20% of your portfolio in the risk free asset and 80% in the risky portfolio.

Explanation / Answer

Answer:(a)

Calculation of expected return of portfolio:

Rp = Wa ER(A)+ Wb ER(B)

Rp= 0.6*14%+0.4*9%

=8.4%+3.6%

= 12%

Calculation of standard deviation of portfolio ?P = sqrt (Wa)2 * variance of A + (Wb)2 * variance of B + 2 WaWb rab ?A ?B

Standard deviation of portfolio ?P : sqrt (0.6)2 *420 +(0.4)2 *165 + 2 (0.6) (0.4) (0.25831063997) (20.4939015319) (12.8452325786)

= sqrt 151.2 +26.4 +32.6399999976

= sqrt 210.239999997

= 14.4996551682

correlation of coefficient of securities of A & B (rab): cov AB/ ?A?B

= 68/(20.4939015319*12.8452325786)

=68/263.24893162

=0.25831063997

Answer b. Risk free assest = 6%

and Expected return from portfolio = 12%

Rp = Wa ER(A)+ Wb ER(B)

= .20*6%+.80*12%

= 10.8%

PARTICULARS STOCK A STOCK B Expected return 14% 9% Variance 420 165 weight 0.6 0.4 Standard deviation = sqrt of variance 20.4939015319 12.8452325786

Related Questions

Navigate

• Browse (All)
• Browse 2
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.