From Ex. 6.5. Portfolio diversification: variance and return. Recall the formulae for variance, covariance, correlation coefficient, and portfolio variance. Suppose 4 stocks have the following characteristics:

Stock Expctd. Return Std. Dev.

A .15 .1

B .2 .15

C .25 .2

D .3 .25

Recall: higher return, higher risk. Suppose now that the following correlations are observed: r(A,B): 1. r(A,C): 0. r(A,D): -1.

What are the risks (portfolio std. dev.) and returns of simple portfolios of 50% A and 50% B? A and C? A and D?