PART A:There are two stocks in your portfolio.

Stock Weight E(r) Variance

A 1/3 9% 0.0036

B 2/3 15% 0.0081

a) Assume stock A and B are perfectly positively correlated, calculate the risk and return for your portfolio.

b) Repeat (a), assume the correlation is 0. Why is the risk now lower than in (a)?

PART B

Over long period of time, share investments tend to substantially outperform bond investments. However, it is not unusual to observe investors with long horizons holding entirely bonds. Are such investors irrational? Please explain.

PART C

Can a portfolio standard deviation be less than the standard deviation of every asset in the portfolio? If yes, please give an example.