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• Expected return (stock A) = (0.1 x -15%)+ (0.2 x 4%)+ (0.5 x 13%) + (0.2 x 38%)= 13.4%
• Expected return (stock B) = 16.80%
• The stock with high risk is compensated with high returns. Based on the answers, stock B is riskier
than stock A, therefore the returns for stock B is higher than stock A.
7. ANSWER
• 7b. Perfect negative correlation = -1 (returns of the two securities are moving in an opposite
direction). In this case, portfolio risk is eliminated through diversification. Thus, it is considered a
risk free portfolio.
• 7c. The correlation coefficient is a measure that determines the degree to which two stocks’ return
movements are associated. The higher the correlation between stocks’ return, the less diversification
effect to reduce risk. The lower the correlation, the more diversification effect to reduce risk.
• Expected return Portfolio 1 = (0.8 x 25) + (0.2 x 33) = 26.6%
• Portfolio 2 = 29.0%
• Portfolio 3 = 29.8%
• Standard deviation Portfolio 1 = √ [ (0.8^2 x 30^2) + (0.2^2 x 45^2)+ (2 x 0.8 x 0.2 x 30 x 45 x 0.2) ] = √
743.4 = 27.27%
• Portfolio 2 = 29.43%
• Portfolio 3 = 31.66%
• Expected return is the anticipated return for some future time period. Realized return is the actual return that
occurred over some past time period.
Expected Return Standard Deviation Coefficient of
Variation = (s.d/ ER)
Portfolio A (0.8 x 12) + (0.2 x 14) 2.81% 2.81/ 12.4 = 0.2266
= 12.4%
Portfolio B 12.5% 2.96% 0.2368
**To get weightage: use investment value divide by the total investment value, e.g, 200/(200 + 50) = 0.8
b. Portfolio A offers a better risk-return combination as it has lower level of risk for every unit of
additional expected return (i.e. lower CV).
c. The efficient frontier (or portfolio frontier) is the set of portfolios which have smallest portfolio
risk for a given level of expected return, or largest expected return for a given level of portfolio risk.