Question

2a. Find the expected return and standard deviation of each stock Probability Return of Stock C Return of Stock D 0.30 - 10% 25% 0.50 15% 10% 0.20 40% 096 2b. Calculate the expected return and standard deviation of a portfolio made up of 50% stock C and 50% stock D if the correlation is -0.75. 2c. Would you prefer to put your money in stock C, stock Dor the 50/50 portfolio? Explain.

Answer 1

2a. Expected Return and Standard Deviation

BL BM BLIOJ BH BI B BK Expected Return Stock C Probability Return Weighted Return 0.30 -10% -3.00% 0.50 15% 7.50% 0.20 40% 8.00% Expected Return 12.50% BN BO BP BQ BR Standard Deviation Stock C Probability Return Expected Return Deviation Squared Deviation Probability * Squared Deviation 0.30 -10% 12.50% -22.50% 0.050625 0.015188 0.50 15% 12.50% 2.50% 0.000625 0.000313 0.20 40% 12.50% 27.50% 0.075625 0.015125 Variance 0.030625 Standard Deviation 17.50% Stock D Probability Return Weighted Return 0.30 25% 7.50% 0.50 10% 5.00% 0.20 0% 0.00% Expected Return 12.50% Stock D Probability Return Expected Return Deviation Squared Deviation Probability * Squared Deviation 0.30 25% 12.50% 12.50% 0.015625 0.004688 0.50 10% 12.50% -2.50% 0.000625 0.000313 0.20 0% 12.50% -12.50% 0.015625 0.003125 Variance 0.008125 Standard Deviation 9.01% 15 16 17

BH BM BI BJBK Expected Return Stock C Probability Return Weighted Return 0.3 -0.1 =B14*BJ4 0.5 0.15 =B15*BJ5 0.2 0.4 =B16*BJ6 Expected Return =SUM(BK4:BK6) BN BO BP ва BR Standard Deviation Stock C Probability Return Expected Return Deviation Squared Deviation Probability * Squared Deviation -0.1 0.125 =B04-BP4 =BQ4^2 =BN4*BR4 0.5 0.15 0.125 =BO5-BP5 =BQ5^2 =BN5*BR5 0.4 0.125 =B06-BP6 =BQ6^2 =BN6*BR6 Variance =SUM(BS4:B56) Standard Deviation =SQRT(BS7) Stock D Probability Return Weighted Return 0.3 0.25 =B111*BJ11 0.5 =B112*BJ12 0.2 =B113*BJ13 Expected Return =SUM(BK11:BK13) 10.1 Stock D Probability Return Expected Return Deviation Squared Deviation Probability * Squared Deviation 0.3 =BJ11 =BK14 =B012-BP12 =BQ1242 =BN12*BR12 0.5 =BJ12 =BP12 =B013-BP13 =BQ1342 =BN13*BR13 =BJ13 =BP13 =B014-BP14 =BQ1412 =BN14*BR14 Variance =SUM(BS12:B514) Standard Deviation =SQRT(BS15)

2b. Portfolio Return = Weight of C * Return of C + Weight of D * Return of D = 0.50 * 12.50% + 0.50 * 12.50% = 12.50%

Portfolio Standard Deviation = Sqrt(Weight of C^2 * SD of C^2 + Weight D^2 * SD of D^2 + 2 * Weight of C * Weight D * SD C * SD D * correlation)

Portfolio Standard Deviation = Sqrt(0.50^2 * 0.1750^2 + 0.50^2 * 0.0901^2 + 2 * 0.1750 * 0.0901 * 0.5 * 0.50 * -0.75)\

Portfolio Standard Deviation = Sqrt(0.003772)

Portfolio Standard Deviation = 6.14%
2c. i would prefer Portfolio with weights of 50% in each stock as it has less standard deviation when compared with individual stock.