Suppose that you have $$100,000$ for investments. Diversification is important in investing. Therefore, you

divide equally the investment money into two stocks: Stock A and Stock B$.$ Based on this setup, compute the

expected returns on the portfolio of Stock A and Stock B $(25$ points$).$ Compute your portfolio risk $(30$ points$).$

Use the following formulae.

Bad Good

A A Bad A Good

$22222$

pf A A B B A B

Bad Bad Good Good

A B Bad A B Good A B A B

$($expected value of stock A$)=()()$

$2$ Cov$($A$,$B$)$

Cov$($A$,$B$)()()()()$

r r P r P

w w w w

r r P r r P r r r r

$$

$$

$$

$$

Where $=$ the weight of your investment in Stock A; $=$ the expected return on Stock A; $$

$2$

is the variance of

the portfolio of Stock A and Stock B; $$ is the standard deviation of returns on Stock A$.$

$2$

is the variance of

returns on Stock A; $$ is the probability of $$bad$$ economic condition in the future. $$

$$ is the expected return

on Stock A if the economic condition is good in the future. Similar letter notations were applied to Stock B$.$