W3a2 3-4: The Capital Market Line and the Security Market Line Problem 3-3 Two-A

Question

W3a2

3-4: The Capital Market Line and the Security Market Line

Problem 3-3

Two-Asset Portfolio

Stock A has an expected return of 11% and a standard deviation of 35%. Stock B has an expected return of 19% and a standard deviation of 55%. The correlation coefficient between Stocks A and B is 0.2.

a)What is the expected return of a portfolio invested 25% in Stock A and 75% in Stock B? Round your answer to two decimal places.

b)What is the standard deviation of a portfolio invested 25% in Stock A and 75% in Stock B? Round your answer to two decimal places.

Explanation / Answer

a) Expected return of portfolio = 11% *.25 + 19% * .75 = 2.75 + 14.25 = 17%

b) standard deviatiuon of portfolio { (.35)2(.25)2+ (.55)2(.75)2+2*.35*.55*.25*.75*0.2}1/2

= (.007656+ 0.170156+ 0.0144375)1/2

= (0.1922495)1/2

= 0.44

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