Consider two hypothetical stocks, X and Y. The expected return on stock X is equal to 9% and the expected return on stock Y is equal to 15%. The standard deviation of stock X and Y are 19% and 27%, respectively. Correlation between the two stocks is 0.487. The risk-free rate is 2.5%.

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Consider portfolio P which is invested 30% in stock X and 70% in stock Y.

a. What is the expected return of portfolio P?

b. What is the standard deviation of portfolio P?

c. How much would you allocate (i.e., what are the weights) to portfolio P and the risk-free asset to create a portfolio with an expected return of 7%?

d.What would be the standard deviation of the combined portfolio (portfolio P and risk-free asset) found in part c? Show all steps.

e.Which has the highest Sharpe ratio, Stock X, Stock Y or portfolio P? Calculate Sharpe ratio of each to reach your decision.

f.What is the expected return and volatility of a portfolio that is created by borrowing 21% at the risk-free rate, and investing 121% in the portfolio P?

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