A portfolio consists of three securities A, B and C with the following parameters:

A B C .:

Expected return (%) 25 22 30

Standard deviation (%) 15 10 18

Correlation (Cor.):

AB +0.35

BC +0.30

AC -0.60

An investor can either invest in Portfolio 1 or Portfolio 2 in the proportion given below.

A B C Portfolio%

1 35 40 25

2 55 35 10

Required: (a) Calculate the expected return and standard deviation for each of the two portfolios (2 Decimal Places). [24 Marks]

(b) Explain the diversification effect and the relationship between correlation of assets. [ 6 Marks]