Question: Please specify whether you agree or disagree with the given arguments and provide the reasons concisely (not exceeding 3 sentences). Suppose that the returns of

Please specify whether you agree or disagree with the given arguments and provide the reasons concisely (not exceeding 3 sentences).

Suppose that the returns of IBM and Merck have independent and identical distribution with 7% of expected return and 25% of standard deviations. Your friend plans to invest in both stocks with an equal weight. Your friend said, Because of the diversification effect, the standard deviation of my portfolio is lower than 20%. This means that my portfolio has lower risks than individual stocks do. Therefore, I think the expected return should be lower than 7% which is the expected return of individual stocks. Do you agree with him?

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