onsider the following information.
Standard deviation of return on the market is 15%
Expected market return is 15%
Risk free rate is 5%
Correlation coefficient of return between stock A and stock B is 0.60 Correlation coefficient of return between stock A and stock C is 0.40 Correlation coefficient of return between stock B and stock C is 0.20
- (i) Calculate expected return for stock A, stock B and stock C.
- (ii) Calculate the expected return and standard deviation of a portfolio which invests one-third in stock A, one-third in stock B, and one-third in stock C.
- (iii) Calculate the expected return and standard deviation of a portfolio which invests one-third in the risk free asset, one-third in stock B, and one-third in stock C.
- (iv) Calculate the expected return and standard deviation of a portfolio which invests 50% in stock B, and 50% in stock C. The investor puts up only 50% of the total amount and borrows the balance from the broker at the risk free rate.
- (v) Compare your answers to (ii), (iii) and (iv) and recommend which portfolio you would prefer giving reasons.
Stock A |
Stock B |
Stock C |
|
Beta |
2.20 |
1.80 |
1.60 |
Standard deviation of return (%) |
60 |
50 |
40 |