The Bank of Tinytown has two $20,000 loans with the following characteristics:

Loan A has an expected return of 10 percent and a standard deviation of returns of 10 percent. The expected return and standard deviation of returns for loan B are 12 percent and 20 percent, respectively.

a. If the correlation of the returns between loans A and B is 0.15, what are the expected return and the standard deviation of this portfolio?

b. What is the standard deviation of the portfolio if the correlation is –0.15?

c. What role does the covariance, or correlation, play in the risk reduction attributes of modern portfolio theory?