Stocks offer an expected rate of return of 10% with a standard deviation of 20%, and gold offers an expected return of 5% with a standard deviation of 25%.
a. In light of the apparent inferiority of gold to stocks with respect to both mean return and volatility, would anyone hold gold? If so, demonstrate graphically why one would do so.
b. How would you answer (a) if the correlation coefficient between gold and stocks were 1.0? Draw a graph illustrating why one would or would not hold gold. Could these expected returns, standard deviations, and correlation represent an equilibrium for the security market?
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