Calculate the followings and verify the diversification effect with the data in the table assuming that with
Question:
Calculate the followings and verify the diversification effect with the data in the table assuming that with the initial endowment of $10,000, you invest $6,000 in Stock A and $4,000 in Stock B. Also four states of the economy are assumed to be equally likely.
| State of Econ | Stock A | Stock B |
| Depression | -20% | 5% |
| Recession | 10% | 20% |
| Normal | 30% | -12% |
| Boom | 50% | 9% |
Q. 1: Expected rate of return for each security
Q. 2: Expected rate of return for the portfolio with the stock A and B
Q. 3: Variance for each security
Q. 4: Standard deviation for each security
Q. 5: Weighted average of standard deviations of two securities
Q. 6: Covariance between securities
Q. 7: Correlation coefficient between securities
Q. 8: Variance of the portfolio
Q. 9: Standard deviation of the portfolio
Q. 10: Compare the weighted average of standard deviations of two securities with the portfolio standard deviation. (a) Did you see diversification effect? (b) Why? Justify your answer in part (a).
Expert Answer:
