Chapter 7, Problem 12CFAP: Abigail Grace has a $900,000 fully diversified portfolio. She subsequently inherits ABC Company common stock worth $100,000. Her financial adviser provided her with the following estimates:

Risk and Return Characteristics:

Expected Monthly Returns; Standard Deviation of Monthly Returns.

Original Portfolio: 0.67%; 2.37%.

ABC Company: 1.25%; 2.95%.

The correlation coefficient of ABC stock returns with the original portfolio returns is .40.

12a. The inheritance changes Graces overall portfolio, and she is deciding whether to keep the ABC stock. Assuming Grace keeps the ABC stock, calculate the:

i. Expected return of her new portfolio, which includes the ABC stock.

ii. Covariance of ABC stock returns with the original portfolio returns.

iii. Standard deviation of her new portfolio, which includes the ABC stock.

12b. If Grace sells the ABC stock, she will invest the proceeds in risk-free government securities yielding .42% monthly. Assuming Grace sells the ABC stock and replaces it with the government securities, calculate the:

i. Expected return of her new portfolio, which includes the government securities.

ii. Covariance of the government security returns with the original portfolio returns.

iii. Standard deviation of her new portfolio, which includes the government securities.