Answer to Question #168703 in Finance for Syed Mudassir Abbas

Question #168703

Q3. Jamie Wong is considering building an investment portfolio containing two stocks, L and M. Stock L will represent 40% of the dollar value of the portfolio, and stock M will account for the other 60%. The expected returns over the next 6 years, 2013–2018, for each of these stocks are shown in the following table.

a. Calculate the expected portfolio return, rp, for each of the 6 years.

b. Calculate the expected value of portfolio returns, , over the 6-year period.

c. Calculate the standard deviation of expected portfolio returns, over the 6-year period.

d. How would you characterize the correlation of returns of the two stocks L and M?

e. Discuss any benefits of diversification achieved by Jamie through creation of the portfolio.

Expert's answer

Let the expected returns be as follows

1 2 3 4 5 6

L 5 6 7 2 2 8

M 4 8 5 7 3 6


expected return on each share:


expected value of portfolio returns


the standard deviation is the square root of the variance


the yield M is greater than the yield L


the yield of M is greater than the yield of L, so the portfolio needs to include more securities of M

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