Question

You have $25,000 to invest in a portfolio containing Stock A and Stock B. Assume that Stock A has an expected return pf 13%, and Stock B has an expected of 9%.

a) How much money will you invest in stock B if your goal is to create a portfolio that has an expected returrn of 11%?

b) How much money will you invest in stock A if your goal is to create a portfolio that has an expected return of 13%? Can we label this portfolio as a "well-diversified" portfolio?

c) How much money will you invest in stock B if your goal is to create a portfolio that has an expected return of 14%? How do you interpret your answer?

Answer 1

a) if i invest 50% in stock a and 50% in stock b then my expected return will be (50%*13%)+(50%*9%)=11%; so I will incest 50% of 25000$ = 12500 in each of the stocks

b)Since the goal is to get 13% returns, only stock a can provide this. Hence invest 100% of the money = $25000 in stock a; this is not a well diversified portfolio since 100% is invested in 1 stock only

c)Since the goal is to create 14% returns, neither stock a nor b nor any combination of them can give you this. One may have to look at other stocks which has an expected return of 14% or greater to do this.