Benefits of

diversification.

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

a.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.

b.Could Sally reduce her total risk even more by using assets M and N only, assets M and O only, or assets N and O only? Use a 50/50 split between the assetpairs, and find the standard deviation of each asset pair.

States		Probability		Asset M Return		Asset N Return		Asset O Return
Boom		29%		13%		22%		5%
Normal		53%		11%		15%		11%
Recession		18%		5%		2%		13%