FIN 435 – Solution to problem set (2-asset portfolios)

1. Consider the following probability distribution for stocks A and B:

State Probability Return on Stock A Return on Stock B

1 0.30 10% 8%
2 0.40 12% 7%
3 0.30 15% 4%

If you invest 40% of your money in A and 60% in B, what would be your portfolio's standard
deviation?

Answer: Portfolio standard deviation = 0.2498%

Stock A Stock B

Expected return 12.300000% 6.400000%

Standard deviation 1.951922% 1.624808%

Covariance -0.000312

Correlation coefficient -0.983762

Portfolio return 8.7600%

Portfolio standard deviation 0.2498%

2. Consider the following probability distribution for stocks A and B:

State Probability Return on Stock A Return on Stock B

1 0.40 15% 20%
2 0.40 12% 12%
3 0.20 9% 24%

If you invest 60% of your money in A and 40% in B, what would be your portfolio's standard
deviation?

Answer: Portfolio standard deviation = 2.2450%

Stock A Stock B

Expected return 12.600000% 17.600000%

Standard deviation 2.244994% 4.800000%

Covariance -0.000096

Correlation coefficient -0.089087

Portfolio return 14.6000%

Portfolio standard deviation 2.2450%

3. Consider the following probability distribution for stocks A and B:

State Probability Return on Stock A Return on Stock B

1 0.50 15% 17%
2 0.20 12% 12%
3 0.30 3% 20%

If you invest 65% of your money in A and 35% in B, what would be your portfolio's standard
deviation?

Answer: Portfolio standard deviation = 2.9600%

Stock A Stock B

Expected return 10.800000% 16.900000%

Standard deviation 5.230679% 2.773085%

Covariance -0.000822

Correlation coefficient -0.566697

Portfolio return 12.9350%

Portfolio standard deviation 2.9600%