2. Consider then a potential portfolio consisting of these stocks. The share of your money going to Stock A is a and that going to Stock B is (1-a). So the return on your portfolio Z = aX + (1-a)Y. Using the result that E(aX + bY)=aE(X) + bE(Y) and var(aX +bY)= a2 var(X) + b2 var(Y) + 2abcov(X,Y), where a and b are constants, var(X) and var(Y) are the variances of returns, and cov(X,Y) is the covariance between the returns of the two stocks.

Compare your portfolio under the following alternative scenarios.

(i) You invest in only one stock. That this, either a=0 or a=1.

(ii) You invest equally in both stocks (a=0.5) and the covariance between the two stocks in 0.592.

(iii) You invest equally in both stocks (a=0.5) and the covariance between the two stocks is -0.592.