Question: Referring to Problem, what would happen if you constructed a portfolio consisting of assets A, B, and C, equally weighted? Would this reduce risk or enhance return?
Problem: You have been asked for your advice in selecting a portfolio of assets and have been supplied with the following data.
Projected Return
Year Asset A Asset B Asset C
2018 12% 16% 12%
2019 14% 14% 14%
2020 16% 12% 16%
You have been told that you can create two portfolios-one consisting of assets A and B and the other consisting of assets A and C-by investing equal proportions (50%) in each of the two component assets.
a. What is the average return, r, for each asset over the three-year period?
b. What is the standard deviation, s, for each asset's return?
c. What is the average return, rp, for each of the portfolios?
d. How would you characterize the correlations of returns of the two assets in each of the portfolios identified in part c?
e. What is the standard deviation of expected returns, sp, for each portfolio?
f. Which portfolio do you recommend? Why?