The standard deviation of Asset A returns is 36%, while the standard deviation of Asset M returns is 24%. The correlation between Asset A and Asset M returns is 0.4.
(a) The average of Asset A and Asset M’s standard deviations is (36+24)/2 = 30%. Consider a portfolio, P, with 50% of funds in Asset A and 50% of funds in Asset M. Will the standard deviation of portfolio P’s returns be greater than, equal to, or less than 30%? Explain this answer intuitively.
(b) What, specifically, will be the standard deviation of portfolio P returns?
(c) Asset M is in fact the “market” portfolio. What is the Beta coefficient for Asset M? For Asset A? For Portfolio P?
(d) Assume that the CAPM holds, that the risk free interest rate is 6% and that the expected return on the market is 14.5%. What is the expected return on Asset A? On portfolio P?