Problem 4

John's father holds just one stock, G Co., which he thinks is a very low risk security. John agrees

that the stock is relatively safe, but he wants to demonstrate to his father that he could still reduce

his risk by diversifying. He obtained the return shown below on G and E Corp. Both have had

less variability than most other stocks over the past 5 years.

Year G E Portfolio:50% G and 50%E

2015 0.40 0.40 ?

2016 -0.10 0.15 ?

2017 0.35 -0.05 ?

2018 -0.05 -0.10 ?

2019 0.15 0.35 ?

Average Return 0.15 0.15 ?

Std dev.s 0.2264 0.22264 ?

a. Measured by the standard deviation of returns, by how much would historical risk have been

reduced if G and E were held in a portfolio consisting of 50% in G and the rest of the money in

E? (Hint: this is a sample, not a complete population, so the sample standard deviation formula

should be used. You can use excel or a calculator to complete the table above)

b. Why is the risk reduced?