Benefits of

diversification.

Sally Rogers has decided to invest her wealth equally across the following three assets:

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. What are her expected returns and the risk from her investment in the three assets? How do they compare with investing in asset M alone?

Hint:

Find the standard deviations of asset M and of the portfolio equally invested in assets M, N, and O.

What is the expected return of investing equally in all three assets M, N, and O?

States

Probability

Asset M Return

Asset N Return

Asset O Return

Boom

34%

12%

22%

4%

Normal

45%

10%

14%

10%

Recession

21%

4%

2%

12%