Consider portfolio P that is comprised from two stocks, A and B. Stock A has a standard deviation of return (A) of 25% while stock B has a standard deviation of return (B) of 40%. The correlation coe?cient between the two stocks () is 0.5.
a. Graph (sketch) the relation between the weight of stock A and the variance of portfolio P. Plot the weight of stock A along the horizontal axis.
b. Derive the formula for the weights of stocks A and B at which the variance of portfolio P is minimal. Hint: Consider the variance of portfolio P as a function of the weight of stock A, wA, and minimize this function with respect to this weight. Find the values of weights.