You have the following information for three securities:
State P Stock AA Stock BB Stock CC
1 .3 .06 .10 .10
2 .2 .14 .22 .10
3 .5 .18 .10 .25
a) Calculate the expected return and variance of return for all three securities
b) Calculate the correlation of return between AA and BB, AA and CC, and BB and CC. Can diversification gains be obtained by combining these three stocks into a portfolio? Why or why not? If you could pick only two of these stocks to combine into a portfolio, which two would you pick? Why?
c) Calculate the expected return and variance of return for a portfolio where 20% of your wealth is invested in AA, 30% in BB, and 50% in CC.
You have the following information for the market portfolio (in addition, the risk-free rate is 9.15%):
State P Market
1 .3 .087
2 .2 .153
3 .5 .177
a) Usethe information above, and the information presented in question 1, to determine the beta for Stock CC?
b) Plot the security market line in expected return, beta space. Label all axes and the points representing the market portfolio, the risk-free asset, and Stock CC. Be sure that you note the expected return and beta for these three points.
c) What is the expected return for a portfolio that has a 40% investment in the risk-free asset, and a 60% investment in Stock CC?