Asset A offers an expected rate of return of 10% with a standard deviation of 25%. Asset B offers

an expected rate of return of 5% with a standard deviation of 30%. Assume that the risk-free

interest rate is zero.

(a) Given that risk and return data of the two assets, would anyone choose to hold Asset B?

Explain your answer graphically. [Hint: Can provide verbal support to the graph, if necessary,

in no more than two lines.]

(6 marks)

(b) Show with calculations that there is NO diversification benefit resulting from forming the

portfolio. [Hint: Take a look at "Supple. Notes on Portfolio Risk Changes with Correlation"

under Topic 2 on Soul and recall the implications of linear and curvy efficient frontiers under

different correlation assumptions.]

(6 marks)

(c) Suppose Assets A and B are perfectly positively correlated. Draw a graph illustrates why a

rational investor would or would not hold Asset B in one's portfolio. [Hint: Can provide verbal

support to the graph, if necessary, in no more than two lines.]

(6 marks)

(d) Suppose Assets A and B are perfectly negatively correlated, form a 2-asset portfolio that has

zero risk (i.e., standard deviation of return equals zero). [Hint: Need to look at the textbook

or other investment textbooks to find the relevant formula to answer this question.]

(6 marks)