5. Portfolio Analysis

DO NOT USE EXCEL! PLEASE SHOW ALL WORK BY HAND!

Suppose there are two common stocks available for investment, stock A and stock B, with the

following characteristics:

Stock A		Stock B
Expected return:	.10	.40
Standard deviation ():	.30	.20
Correlation coefficient (p):	-.7

(A) Calculate the portfolio expected return and standard deviation of return for each of the

following portfolios:

Portfolio	Proportion in A	Proportion in B
1	1	0
2	2/3	1/3
3	1/3	2/3
4	0	1

(B) Sketch (this does not have to be a work of art, but try to be careful) the feasible set of all

portfolios composed of A and B.

(C) Suppose that there is now the opportunity to borrow or lend at the risk-free rate of return,

which is 10%. Show on your sketch in part (B) how this changes the investment opportunities

available. (Be sure to clearly label this PART C.)

(D) Assume you are a rational investor and can invest in stock A, stock B, the risk-free security,

or any combination thereof. Further assume that you have $150,000 and decide to invest

$60,000 in the risk-free security and $90,000 in risky securities. Approximately how much money will you invest in Security B? Briefly explain how you arrived at your answer.