Computing the standard deviation for a portfolio of two risky investments) Mary Guillot recently graduated from Nichols State University and is anxious to begin investing her meager savings as a way of applying what she has learned in business school. Specifically, she is evaluating an investment in a portfolio comprised of two firms’ common stock. She has collected the following information about the common stock of Firm A and Firm B:
|
Expected Return |
Standard Deviation |
||
|
Firm A’s common stock |
0.170.17 |
0.190.19 |
|
|
Firm B’s common stock |
0.180.18 |
0.240.24 |
|
|
Correlation coefficient |
0.400.40 |
||
a. If Mary invests half her money in each of the two common stocks, what are the portfolio’s expected rate of return and standard deviation in portfolio return?
b. Answer part a where the correlation between the two common stock investments is equal to zero.
c. Answer part a where the correlation between the two common stock investments is equal to plus1.
d. Answer part a where the correlation between the two common stock investments is equal to minus1.
e. Using your responses to questions along dashed describe the relationship between the correlation and the risk and return of the portfolio.
