4.2 Table Economic Probability of Rate of Return If Economic State Occurs State

Question

4.2 Table

Economic Probability of Rate of Return If Economic State Occurs
State Occurrence A B C D

Very Poor 0.10 -10% 30% - 25% 15%
Poor 0.20 0 20 -5 10
Average 0.40 10 10 15 0
Good 0.20 20 0 35 25
Very Good 0.10 0 -10 55 35
1.00

Expected Rate of return 10.0% 10.0% 15.0% 12.0%
Standard deviation 11.0% 11.0% 21.9% 12.1%

Refer to table 4.2
a. Construct an equal-weighted (50/50) portfolio of Investments B and D. What is the expected rate of return and standard deviation of the portfolio? Explain your results.

Explanation / Answer

Correction For B & D Equal-weighted (50/50) portfolio of Investments B and D. Expected rate of return of portfolio = 0.5*Expected rate of return of B + 0.5* Expected rate of return of D = 0.5*10% +0.5*12% = 11% Standard deviation of the portfolio = sqrt([(0.5)*(standard deviation of B)]^2 + [(0.5)*(standard deviation of D)]^2) =sqrt([(0.5)*.11]^2 + [(0.5)*.121]^2) = 8.1%

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