Consider two different stocks, X and Y, with expected returns X = 17.0% and Y = 14.9% and with standard deviations X = 12.4% and Y = 10.0% for those returns. The two assets have a correlation, , of -0.7. a. What is the covariance of the returns of stocks X and Y? (Hint: use the definition of the population correlation to compute the covariance) In general, will constructing a portfolio from these two stocks reduce or increase the risk compared to the individual stocks? Briefly explain.

b. What is the expected return and standard deviation of a portfolio made up of stocks X and Y which is 20% stock X (the remainder stock Y)? 1 https://www.pfizer.com/news/press-release/press-release-detail/pfizer-and-biontech-conclude-phase-3- study-covid-19-vaccine. 4 Final Exam

c. What is the expected return and standard deviation of a portfolio made up of stocks X and Y which is 50% stock X? d. What is the expected return and standard deviation of a portfolio made up of stocks X and Y which is 80% stock X?

e. Which of the portfolios above, either (b), (c), or (d), offers the best combination of risk and return? Briefly explain.