At the beginning of 2020 you invest $3,000 in Microsoft (MSFT)
stock and $5,000 in Proctor and Gamble (PG) stock.
Suppose you expect the monthly return to be 1.2% for MSTF and 0.5%
for PG and the standard deviation of monthly returns to be 11.6%
for MSTF and 6.5% for PG, and that the correlation of the returns
on the two stock is 0.18.
- What are the expected monthly return on your portfolio and its
stand dard deviation?
- Compare and discuss the return and standard deviation of the portfolio to the return and standard deviation of the two individual stocks.
Percentage Invested in Microsoft = (3000 / 8000) = 37.5%
Percentage Invested in Procter & gamble = (5000 / 8000) = 62.5%
Monthly return for Microsoft = 1.2%
Monthly return for Procter & gamble = 0.5%
Expected monthly return on portfolio = ( Weight of Stock A * Return of Stock A ) + ( Weight of Stock B * Return of Stock B )
= (0.375 * 1.2%) + (0.625 * 0.5%) = 0.76%
Expected standard deviation of portfolio = [ { ( Weight of Stock A * Std Deviation of Stock A) ^ 2 } + { ( Weight of Stock B * Std Deviation of Stock B) ^ 2 } + 2 * Weight of Stock A * Weight of Stock B * Correlation of Stock A & B * Std Deviation of Stock A * Std Deviation of Stock B ] ^ (1/2)
= 6.46%
Portfolio return will lie between Returns of 2 Stocks while Standard Deviation reduces to 6.46% on account of benefit of diversification
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