Question

Question 1 gives you the information of the stocks and their correlation, which will be used in many of the following questions.

James, a portfolio manager, would like to form the following portfolio between Microsoft and Coca-Cola:

            Expected return (%)      Standard Deviation (%) Weight

Microsoft                 28                          42                    0.4                  

Coca-Cola              12.5                         21                    0.6

The correlation between the two stocks is 0.5.

What is the expected return and standard deviation of the portfolio?

Answer 1

Expected return of portfolio is weighted average of the return of constituents.

Expected return = Weight1 * return1 + Weight2 * Return2

Expected Return = 40% * 28% + 60% * 12.5%

Expected Return = 18.70%

Oportfolio = wig+wo3 + 2wW2P1,20102 Where: W W 04 02 P12 = = = = = Proportion of the portfolio invested in Asset 1 Proportion of the portfolio invested in Asset 2 Asset 1 standard deviation of returns Asset 2 standard deviation of returns Correlation coefficient between the returns of Asset 1 and Asset 2

0 = V(0.40 * 0.42)2 + (0.60 * 0.21)2 + (2*0.40 * 0.60 * 0.42* 0.21* 0,5)

0 = V0.028224 +0.015876 +0.021168

0 = V0.065268

O = 0.2555

Standard deviation = 25.55%