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Question 2 (10 marks/Diversification benefit) Consider two stocks A and B. Stock A has an expected return of 20% and a standard deviation of 25%.
Question 2 (10 marks/Diversification benefit) Consider two stocks A and B. Stock A has an expected return of 20% and a standard deviation of 25%. Stock B has an expected return of 16% and a standard deviation of 13%. The correlation between the returns of A and B is +0.3. a) Will forming a 2-asset portfolio using stocks A and B help diversify investment risk? Explain. [Note: No calculation is required.] (2 marks) b) What is the expected return and standard deviation of a portfolio with 60% in Stock A? (4 marks) c) Is there any diversification benefit resulting from forming the portfolio? Support your answer with calculation. (Hint: Class discussion concluded that there will be no diversification benefit if corrxv = +1.) (4 marks)
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