[no excel please, try to learn from the exam, need to show All you work, thanks!!!]

Suppose you have $30,000 to invest in two securities: Spot and Dot. After doing an extensive analysis of the economy and the two securities, you came up with the following forecasts:

State of Economy	Probability of Occurrence	Spot Expected Return	Dot Expected Return
Boom	15%	-8%	35%
Normal	60%	14%	20%
Bust	25%	18%	-10%

a. What are the expected returns of Spot and Dot shares?

b. what are the standard deviations of the returns on Spot and Dot?

c. Estimate the covariance of the returns on Spot and Dot

d. What is the correlation coefficient between Spot and Dot return?

e. How much of the money should be invested in Spot and how much in Dot if you wish to have an expected return of 12% on the portfolio?

f. Compute the standard deviation of the portfolio in e.

g. Why does diversification reduce risk? Answer the question with reference to why the standards deviation of the portfolio in f above is lower than the standard deviation of the two stocks in b that make up the portfolio.

NOTE: Question g is important, need a detailed explanation, thanks!!!!