Jamie Wong is considering building an investment portfolio containing two stocks, L and M. Stock L will represent 40% of the dollar value of the portfolio, and stock M will account for the other 60%. The expected returns over the next 6 years, 2010-2015, for each of these stocks are shown in the following table:
Expected return
Year Stock L Stock M
2010 14% 20%
2011 14 18
2012 16 16
2013 17 14
2014 17 12
2015 19 10
a. Calculate the expected portfolio return, rp, for each of the 6 years.
b. Calculate the expected value of portfolio returns, p, over the 6-year period.
c. Calculate the standard deviation of expected portfolio returns, σrp, over the 6-year period.
d. How would you characterize the correlation of returns of the two stocks L and M?
e. Discuss any benefits of diversification achieved by Jamie through creation of the portfolio.