Consider an economy with two types of firms: S and I. S firms all move together. I firms move independently. For both types of firms there is a 50% probability that the firm will have a 12% return and a 50% probability that the firm will have a -11% return.
What is the volatility (standard deviation) of a portfolio that consists of an equal investment in 25 type S firms? What is the volatility (standarddeviation) of a portfolio that consists of an equal investment in 25 type I firms?