Question
Consider the following details regarding risk and expected return for four assets: Asset Standard Deviation (% p.a.) Treasury Bill 0 Shares in Disney Ltd 17.7
Consider the following details regarding risk and expected return for four assets:
Asset | Standard Deviation (% p.a.) |
Treasury Bill | 0 |
Shares in Disney Ltd | 17.7 |
Shares in MGM Resorts International | 30.8 |
S&P500 Index | 11.3 |
You also know that the correlation coefficients between the returns of the assets are as follows:
| Treasury Bill | Disney Ltd | MGM Resorts | S&P500 |
Treasury Bill | 1.0 |
|
|
|
Disney Ltd | 0 | 1.0 |
|
|
MGM Resorts | 0 | 0.47 | 1.0 |
|
S&P500 | 0 | 0.74 | 0.55 | 1.0 |
Your brother has a portfolio that currently only consists of shares in Disney Ltd. He comes to you and asks your advice on diversifying his portfolio such that half of his wealth is invested in Disney Ltd and half in MGM Resorts International.
1. Calculate the standard deviation of the returns of the portfolio following your brothers proposed investment in MGM Resorts [express to two decimal places eg. 35.24%].
Use the information from question 1 to assist in answering question 2:
Your brother gets very angry when you tell him what the standard deviation of the returns of the portfolio will be following his proposed diversification saying; This is crazy by following your advice my risk has actually increased!! What sort of silliness is this?
2. Provide a short response to your brother (including a calculation) that demonstrates the impact of diversification (maximum 100 words).
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