Question 2 Samantha Smarth is the Investment Manager at Guillott Corporation and is currently considering whether to make an investment in the stocks of Huck Finn Inc. (HFI) and Fitzgerald Enterprises (FE). During her research, she noted that the performance of the two companies will hinge greatly on how the national economy performs in the coming year. Specifically, she is studying the following possible outcomes: State of the Economy Probability of Occurrence Expected Return (%) HFI FE Expansion Normal Recession 35% 15% 25% 20% 10% 20% ??? 2% 1% Samantha is considering investing a total of $2 million, with an investment of $1,500,000 in HFI stocks and the remainder in FE stocks. She knows that the two stocks tend to earn high returns and low returns at about the same times in the business cycle and as such has assigned a correlation coefficient of 0.75. Required: (i) Define and briefly discuss the value of diversification for investors. (4 marks) TURN OVER The University of the West Indies Course Code: MGMT3048 3 2014/07/ Question 2 (Continued) (ii) Calculate the expected return and standard deviation of each stock and state which stock has the highest risk. (8 marks) (iii) If Samantha invests in the two stocks as planned, calculate the expected return on her portfolio as well as the standard deviation. (8 marks)