Investment Theory

4. Your current portfolio of $750,000 is fully diversified, yielding an expected monthly return of 0.67% with a monthly return volatility of 2.37%. You expect to inherit $250,000 of company A stock, which has an expected return of 1.25% a month and a monthly return standard deviation of 2.95%. The correlation of stock A with your current portfolio is 0.4. a. Assuming you keep the stock, compute the monthly expected return and standard deviation of the new portfolio (i.e. the total portfolio that includes your current portfolio and the new stock)? b. What is the annualized expected return of the portfolio from part a? What is the annualized volatility? C. A friend suggests selling stock A and investing the proceeds in stock of firm B instead. Stock B has the same expected return and volatility level as A. Are you indifferent between these two alternatives? d. You discuss your alternatives with your financial adviser, commenting I am more concerned about the downside of losing money than I am about overall total risk. What other risk measures might your financial adviser suggest (in addition to standard deviation)? How would those affect your reward-for-volatility ratio? Explain