Consider two different stocks, X and Y, with expected returns muX = 17.0% and muY = 14.9% and with standard deviations sdX = 12.4% and sdY = 10.0% for those returns. The two assets have a correlation, p, of -0.7.

1. What is the covariance of the returns of stocks X and Y? (Hint: use the definition of the population correlation p 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.

2. 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)?

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

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

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