Problem
i. You can get the same return for lower risk by holding a basket of two stocks rather than just one, when the return on these stocks are uncorrelated. Discuss what difference it would make if the returns on the two assets were either (a) negatively or (b) positively correlated.
ii. Explain the factors that affect the risk structure of interest rates. Explain how a change in each factor changes interest rates. Why do municipal bonds often have lower interest rates than default-free Treasury bonds?