Question: You are currently holding stock A which has expected return of 10% and standard deviation of 3%. You would like to add one of the

You are currently holding stock A which has expected return of 10% and standard deviation of 3%. You would like to add one of the following two stocks (so you would like to have a portfolio with two stocks):

B	C
10%	10%	E(ri)
4%	2%	(i)

a. Which stock should you buy assuming that all three stocks are uncorrelated and you can only purchase one of the stocks B or C?

b. Now assume that

(A,B) = 0.5 and (A,C) = 0. Which stock will you buy now?

c. Now assume that (A,C) = -1 and you are investing only in stocks A and

C. What are the optimal weights of stocks A and C in your portfolio? If there is a risk free rate in the market, what is the risk free return?

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