You are responsible for managing a portfolio of two investments for the coming year. You have read all of the latest financial news and according to your favourite reputable financial analysts, the probability of another recession occurring is 30% and the probability of a boom is 20%; otherwise the economy will be behaving normally.
Shares of Firm A are expected to earn a return of 15% during boom times, but lose 10% during a recession. Normally, the firm's common shares would earn a 10% return.
The price of Firm B's shares is expected to decline 10% during boom times, but increase by 15% during a recession. Normally the firm's common shares would also earn a 10% return.
Perform a financial analysis for the purpose of calculating your expected investment return.
Please show your work/provide the complete solution to the best of your ability for your answer.
a) Find the Minimum Variance Portfolio (MVP) consisting of some combination of shares of both Firm A and Firm B. What proportion of the portfolio must be invested in Firm A's common shares and what proportion in those of firm B to achieve the MVP?
b) What is the standard deviation of expected returns on the MVP?
c) What is the expected return on the MVP?