You can only invest in two securities: A and X. The correlation between the returns of...

 

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You can only invest in two securities: A and X. The correlation between the returns of A and X is 0.2. Expected returns and standard deviations are as follows: Security E[R] A X o(R) 20% 20% 15% 25% a) It seems that A dominates X in that it has a higher expected return and lower standard deviation. Would anyone ever invest in X? Why? b) What is the expected return and standard deviation of a portfolio that invests 60% in A and 40% in X? c) Suppose instead that you want your portfolio to have an expected return of 19.5%. What portfolio weights do you select now? What is the standard deviation of this portfolio? You can only invest in two securities: A and X. The correlation between the returns of A and X is 0.2. Expected returns and standard deviations are as follows: Security E[R] A X o(R) 20% 20% 15% 25% a) It seems that A dominates X in that it has a higher expected return and lower standard deviation. Would anyone ever invest in X? Why? b) What is the expected return and standard deviation of a portfolio that invests 60% in A and 40% in X? c) Suppose instead that you want your portfolio to have an expected return of 19.5%. What portfolio weights do you select now? What is the standard deviation of this portfolio?

Answer rating: 100% (QA)

a Yes some investors may still choose to invest in X despite its lower expected return and higher volatility compared to A The reason is that diversif... View the full answer