FinCorp Inc. is interested in the tradeoff between investing in two stocks, ABC and DEF. The expected return on ABC is 6 percent and on DEF is 18 percent.
a. Graph the relationship between expected return on the portfolio and the weight in DEF.
Weight in DEF Portfolio return
0% 6%
1% 6.12%
2% 6.24%
3% 6.36%
99% 17.88%
100% 18%
b. What is the tradeoff between investing in ABC and DEF (i.e., if we increase the weight in DEF by 1%, what is the change in the expected return on the portfolio)?
c. Your boss has just looked at your results and disagrees. He says the tradeoff between DEF and ABC is negative and, therefore, your results are wrong. Explain to your boss how you are both correct.