Question
Suppose Susan is deciding how to allocate her portfolio between two asset classes: risk-free government bonds and a risky group of diversified stocks. The following
Suppose Susan is deciding how to allocate her portfolio between two asset classes: risk-free government bonds and a risky group of diversified stocks. The following table shows the risk and returns associated with different combinations of stocks and bonds. The standard deviation of the portfolio is the measurement of risk.
Portfolio | % stocks | % Bonds | Average Annual Return | Standard Deviation of Portfolio Return (Risk) |
A | 0 | 100 | 2.0 | 0 |
B | 25 | 75 | 3.5 | 5 |
C | 50 | 50 | 5.0 | 10 |
D | 75 | 25 | 6.50 | 15 |
E | 100 | 0 | 8.00 | 20 |
Answer the following four questions.
Question 1: Currently, Susan has selected the "C" portfolio (50% stocks and 50% bonds). What are Susan's expected returns and risks?
Question 2: Explain how standard deviation explains risks in investing.
Questions 3: If Susan decides to reallocate her investments by selecting the "D" portfolio (75% stocks and 25% bonds), Explain to Susan her expected returns of investments, the risk she is taking, and the returns she is expected to receive from her "D" portfolio.
Question 4: If you were her financial adviser, explain to her how her selection of the "D" portfolio can impact her retirement. Susan is 60 years old. Is she making a good decision to take additional risks for higher returns?
Answer the following two questions.
Question 1: Explain the efficient market hypothesis?
Question 2: Can you beat the market? Explain your answer in detail.
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