Intro

The following table shows realized rates of return for two stocks.

	A	B	C
1	Year	Stock A	Stock B
2	1	5%	15%
3	2	-14%	-14%
4	3	-6%	-9%
5	4	5%	28%
6	5	14%	8%
7	6	12%	4%

Attempt 1/10 for 10 pts.

Part 1

What is the arithmetic average return for stock B?

Attempt 1/10 for 10 pts.

Part 2

What is the standard deviation for stock B?

Attempt 1/10 for 10 pts.

Part 3

What is the correlation of returns?

Attempt 1/10 for 10 pts.

Part 4

What is the expected return of a portfolio with 50% invested in stock A and the remainder in stock B?

Attempt 1/10 for 10 pts.

Part 5

What is the standard deviation of a portfolio with 50% invested in stock A and the remainder in stock B?

Attempt 1/8 for 8 pts.

Part 6

What should a rational, risk-averse investor do?

Invest only in stock A

Invest in both stocks

Invest only in stock B

Invest in neither stock

Correct

Since the correlation between the two stocks' returns is less than perfect (<1), there is a benefit from diversification, in the sense that the portfolio standard deviation is less than the average of the two individual standard deviations.