Question 2

Suppose that there exist two securities (A and B) with annual expected returns equal to = 3% and =

5% and standard deviations equal to = 7% and = 10% respectively. The correlation coefficient

between the returns of these securities is = 0.5.

2.1 What is the expected return and the standard deviation of an equally weighted portfolio consisting

of the securities A and B? Describe every step of your calculations in detail.

(15%)

2.2 What is the expected return and the standard deviation of a portfolio consisting of the securities A

and B, if the relevant weights are chosen to minimize the risk of the portfolio? Present the

minimisation problem and describe every step of your calculations in detail.

(20%)

2.3 How could an investor maximize diversification benefits? Critically discuss and explain in detail.

(15%)