Benefits of diversification.

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

States

Probability

Asset M Return

Asset N Return

Asset O Return

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Boom

25%

14%

24%

6%

Normal

53%

12%

16%

12%

Recession

22%

6%

4%

14%

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

(Round to two decimal places.)

What is the expected return of investing in asset M alone?

(Round to two decimal places.)

What is the standard deviation of the portfolio that invests equally in all three assets M, N, and O?

(Round to two decimal places.)

What is the standard deviation of asset M?

(Round to two decimal places.)

By investing in the portfolio that invests equally in all three assets M, N, and O rather than asset M alone, Sally can benefit by increasing her return by_______

and decreasing her risk by_______.

(Round to two decimal places.)