Determine the expected return and variance of a portfolio


The expected returns, return variances, and the correlation between the returns of four securities are shown below.

Security   Expected Return    Variance of Returns   Correlation

                                                                               A     B      C     D

A                 0.17                         0.0169               1.0  0.4    0.7    0.2
B                 0.13                         0.0361                      1.0    0.6    0.5    
C                0.09                          0.0049                                0.1   0.9                        
D                0.07                          0.0050                                         1.0

a. Determine the expected return and variance for a portfolio composed of 25% of security A and 75% of security B.

b. Determine the expected return and variance of a portfolio that contains 78% security A and 22% security B. Is this portfolio superior to that one in (a) above?

c. Calculate the expected return and variance of a portfolio that contains 60% security C and 40% security D.

d. If an investor were to select among the following three portfolios, which one would he or she prefer?

o An equally-weighted portfolio of securities A, B, and C.
o An equally-weighted portfolio of A, B, and D.
o An equally-weighted portfolio of B, C, and D.

e. If a risk-adverse investor desires to hold a portfolio of only two securities and expects a return of 11%, what would you advise the investor to do?

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Finance Basics: Determine the expected return and variance of a portfolio
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