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Question 3 Gloria Gomez has a portfolio worth $80,000. She subsequently inherits ABC Company common stock worth $20,000. Her financial advisor provided her with the
Question 3 Gloria Gomez has a portfolio worth $80,000. She subsequently inherits ABC Company common stock worth $20,000. Her financial advisor provided her with the following forecasted information: The correlation coefficient of ABC stock returns with the original portfolio returns is 0.40 . The riskfree rate Gloria can earn by investing in government securities is 4% per year. a) The inheritance changes Gloria's overall portfolio and she is deciding whether to keep the ABC stock. Assuming Gloria keeps the ABC stock, calculate: a.1) the expected return of Gloria's new portfolio (which includes the ABC stock). a.2) the standard deviation of Gloria's new portfolio (which includes the ABC stock). b) Based on conversations with her husband, Gloria is considering selling the $20,000 of ABC stock and acquiring $20,000 of XYZ Company common stock instead. XYZ stock has the same expected return and standard deviation as ABC stock BUT DIFFERENT correlation with the original portfolio. Her husband comments, "It does not matter whether you keep all the ABC stock or replace it with $20,000 of XYZ stock." State whether her husband's comment is correct or incorrect. Justify your response. c) Assuming Gloria sells the ABC stock and invests all the proceeds from ABC stock with the riskfree asset, calculate: c.1) the expected return of Gloria's new portfolio (which includes the risk-free asset). c.2) the standard deviation of Gloria's new portfolio (which includes the risk-free asset). d) Gloria has an utility function of the form U=E(rC)1/2A(C)2 with risk aversion A=3. Is she better off keeping stock ABC (item a) or replacing it by the risk-free asset (item c)? Justify your answer. e) Gloria has an utility function of the form U=E(rC)1/2A(C)2 with risk aversion A=3. Suppose she decides to allocate her total wealth (i.e., her original wealth plus the inheritance) optimally between her original portfolio and the risk-free asset (so, having zero in ABC stock). How much money should she have in the risk-free asset
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