Consider the following possible rates of returns on stock A, stock B, and stock C over the
Question:
Consider the following possible rates of returns on stock A, stock B, and stock C over the next year:
State of economy | Probability of state occurring | Return on stock A | Return on stock B | Return on stock C |
Recession | 0.2 | -6% | 18% | -5% |
Normal | 0.5 | 10% | 6% | 8% |
Boom | 0.3 | 16% | -18% | 10% |
1) What are the expected rates of returns on stock A, stock B, and stock C?
2) What are the standard deviations of returns on stock A, stock B, and stock C?
3) What is the correlation between the returns on stocks A and B?
4) Calculate the expected rate of return and standard deviation of a portfolio that is composed of 40% of A and 60% of B?
5) What will be the expected return and standard deviation of your investment, if you invest $4,800 in stock A, $3,600 in stock B, and $3,600 in stock C for one year? What will the expected return, if the holding period is 7 months?
6) Are there diversification benefits associated with forming the portfolio in part (d)? Explain why or why not.
Expert Answer:
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