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The following are possible states of the economy and the returns associated with stocks A and B in those states
The following are possible states of the economy and the returns associated with stocks A and B in those states. Probability Return on A State on B Return 0.25 24% Good 30% Normal 0.4 36% 18% 0135 48% Bad -6% Calculate the expected return and the standard deviation of a portfolio comprised of stocks A and B. The weight in stock A is 40%. B Ti
Expert Solution
Weight of Stock A = 40%
Weight of Stock B = 60%
Good:
Expected Return = 0.40 * 0.24 + 0.60 * 0.30
Expected Return = 0.2760
Normal:
Expected Return = 0.40 * 0.36 + 0.60 * 0.18
Expected Return = 0.2520
Bad:
Expected Return = 0.40 * 0.48 + 0.60 * (-0.06)
Expected Return = 0.1560
Expected Return of Portfolio = 0.25 * 0.2760 + 0.40 * 0.2520 + 0.35 * 0.1560
Expected Return of Portfolio = 0.2244 or 22.44%
Variance of Portfolio = 0.25 * (0.2760 - 0.2244)^2 + 0.40 * (0.2520 - 0.2244)^2 + 0.35 * (0.1560 - 0.2244)^2
Variance of Portfolio = 0.002608
Standard Deviation of Portfolio = (0.002608)^(1/2)
Standard Deviation of Portfolio = 0.0511 or 5.11%
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