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You are creating a portfolio of Stock D and Stock BW (from earlier)
You are creating a portfolio of Stock D and Stock BW (from earlier). You are investing $2,000 in Stock BW and $3,000 in Stock D. Remember that the expected return and standard deviation of Stock BW is 9% and 13.15% respectively. The expected return and standard deviation of Stock D is 8% and 10.65% respectively. The correlation coefficient between BW and D is 0.75. What is the expected return and standard deviation of the portfolio?
Expert Solution
Position in Stock D = $3000
Position in Stock BW = $2000
Weight in Stock D = $3000 / ($3000 + $2000) = 60%
Weight in Stock BW = $2000 / ($3000 + $2000) = 40%
Expected return of Stock BW = 9%
Expected return of Stock D = 8%
Standard Deviation of Stock BW = 13.15%
Standard Deviation of Stock D = 10.65%
Correlation coefficient (BW,D) = 0.75
Expected return of portfolio = Weight in Stock D * Expected return of Stock D + Weight in Stock BW * Expected return of Stock BW
Expected return of portfolio = 60% * 8% + 40% * 9%
Expected return of portfolio = 8.4%
Standard Deviation of portfolio = 
(Weight in Stock D * Standard Deviation of Stock D)2 + (Weight in Stock BW * Standard Deviation of Stock BW)2 + (2 * Weight in Stock D * Weight in Stock BW * Standard Deviation of Stock D * Standard Deviation of Stock BW * Correlation coefficient (BW,D)
Standard Deviation of portfolio = (60% * 10.65%)2 + (40% * 13.15%)2 + (2 * 60% * 40% * 10.65% * 13.15% * 0.75)
Standard Deviation of portfolio = 0.01189
Standard Deviation of portfolio = 10.90%
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