Problem
Stock A has an expected return of 6% and a standard deviation of return of 11%. Stock B has an expected return of 10% and a standard deviation of return of 28%. The correlation coefficient between the returns of stocks A and B is 0.10. Assume the risk-free rate is 2%.
1) Suppose you require that your portfolio yield an expected return of 9% and that it be efficient on best feasible Capital Allocation Line. What is the portion invested in the risk free asset and in the two risky stocks?
2) What is the standard deviation of this portfolio?
3) Now suppose there is no risk-free asset. If you were only to invest in the 2 risky stocks and still require an expected return of 9%, what would be the standard deviation on of this portfolio? Compare the standard deviation of this portfolio to the standard deviation of the portfolio with a risk-free asset. Interpret your results.