Economic Return on Asset

Conditions Probability A B C

Boom .30 60% 50% 10%

Normal .40 40 30 50

Bust .30 20 10 90

Portfolio AB is formed by investing 50% of the funds in each of the assets A and B. A similar (equally weighted) portfolio has also been created from A and C, called AC. Find the rates of return not given for AB and AC.

Econ AB= AC=

Conditions Probability .50A+.50B .50A+.50C

Boom .30 55 35%

Normal .40 35 ?

Bust .30 15 ?

Find the expected return and standard deviation of AB and AC. (The formulas are given in 1 above.) Do you see any evidence of risk reduction from the numbers you obtain? What do you think caused this?