11.4 The standard deviation should decrease because there is now a lower probability of the more extreme outcomes. The expected rate of return on the auto stock is now [.3X(-8%)]+(.45%)+(.318%)=5% The variance is [.3X(-8-5)2]+[.4x(5-5)2]+[.3x(18-5)]=101.4 The standard deviation is 101.4 -10.07%, which is lower than the value assuming equal probabilities of each scenario.

11.5 The gold mining stock's returns are more highly correlated with the silver mining company than with a car company. As a result, the automotive firm will offer a greater diversification benefit. The power of diversification is lowest when rates of return are highly correlated, per- forming well or poorly in tandem. Shifting part of the portfolio from one such firm to another has little impact on overall risk.