You have two stocks with the following Expected Returns (ER) and Standard Deviations (SD). Stock A: ER = 5%, SD = 5%. Stock B: ER = 10%, SD = 10%. The correlation coefficient is 0.5.
Show how you can create a portfolio with these two stocks which would have an ER of 8%. What is the SD of this portfolio?
First we have to calculate Wa and Wb. Afterwards we can enter the SD calculation.
Wa calculation - Let's use the following formula:
0.08 = 0.05Wa + 0.1Wb 0.08 = 0.05Wa x 0.1(1-Wa) 0.08 = 0.05Wa x 0.1-0.1Wa -0.02 = -0.05Wa 0.02 = 0.05Wa Wa = 0.02/0.05 Wa = 0.04
So we have Wa equal 40%
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