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a. Suppose you are building a two-asset portfolio with stocks A and B. Stock A Stock B Expected Return 15% 21% Standard Deviation 5% 8%

a. Suppose you are building a two-asset portfolio with stocks A and B.

Stock A Stock B

Expected Return 15% 21%

Standard Deviation 5% 8%

Explain, with the aid of a diagram, the conditions under which the portfolio with A and B dominates a risk-free asset. (10 marks)

b. Explain, with the aid of an equation, the conditions under which covariances of stock returns are the major determinants of the risk of a portfolio. (10 marks)

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