1. Explain why it is important to have diversification in a portfolio.
2. The following table represents a portfolio of two (2) assets:

State of NatureProbability of State of NatureReturn of Stock A under Different State of NatureReturn of Stock B under Different State of Nature

Boom

Normal

Recession

0.3

0.5

0.2

20%

10%

5%

25%

20%

10%

1. What is the expected return on Stock A and Stock B?
2. What is the standard deviation of returns of Stock A and Stock B?
3. Which Stock is more volatile?

E(r_a) = R_i P_r

Variance = ²= ( R_i E(r)] ²P_r

Sd = =variance

CV= Standard deviation/ Expected return =/R

i. What is the expected return on Stock A and Stock B? (2 marks) ii. What is the standard deviation of returns of Stock A and Stock B? (4 marks) iii. Which Stock is more volatile? (2 marks)