1. Using historical data to measure portfolio risk and correlation coefficient

Michael is an investor who believes that past variability of stocks is a reasonably good estimate of future risk associated with the stocks. Michael works on creating a new portfolio and has already purchased stock A. Now he considers two other stocks, B and C. Michael collected data on the historic rates of return for all three stocks, which are presented in the following table. Complete the table by calculating standard deviations for each stock:

Year	Stock A	Stock B	Stock C
2015	30%	25%	-10%
2016	25%	30%	-5%
2017	-5%	-10%	30%
2018	-10%	-5%	25%
Average return	10%	10%	10%
Estimated standard deviation	20.41%	20.41%	20.41%

Suppose Michael can only afford to complement stock A by adding just one of the two other stocks, either stock B or stock C. Complete the following table by computing correlation coefficients between stocks A and B and between stocks A and C, and calculate average returns and standard deviation for the two potential portfolios, AB and AC:

	Stocks A and B	Stocks A and C
Correlation coefficient	0.96	-0.98
Average return	10%	10%
Standard deviation

Suppose Michael has to choose between two portfolios, AB and AC. Michael will be better off choosingPortfolio AB .

Which of the following statements about portfolio diversifications are correct? Check all that apply.

Diversification can reduce risk but not eliminate it.

Correlation between returns on stocks of small companies is smaller than returns on stocks of big companies.

Returns on stocks in the same industry are more closely correlated than on stocks in different industries.

Portfolios that include stocks of only big companies minimize risk.