The following table provides information on two risky stocks that you think, given some special information, are good investments.

Stock Expected Return Variance of Return

A .15 .01

B .25 .09

The correlation between these two stocks is .2. The expected return on the market is .23 with a standard deviation of .25. The risk-free rate is .05. You can borrow and lend at this risk-free rate.

You have $10,000 to invest. Some of this you may put in risk free T-bills, with the remainder invested in a portfolio of the two stocks above. Consider a portfolio that has 40 percent of the amount you put at risk in Stock A and 60 percent in Stock B. Call the portfolio that consists of Stock A and Stock B your risky portfolio. For this risky portfolio, answer the following questions.

a. What is the expected return of the risky portfolio? (6 points)

b. What is the standard deviation of the return of the risky portfolio? (6 points)

c. For the risky portfolio, what is the Sharpe measure? (6 points)

d. You have a choice between forming a total portfolio of risk free investments and either the risky portfolio above or the risky market portfolio. Which of the following risky portfolios would you prefer to hold in your total portfolio: (1) the above portfolio with Stock A and Stock B or (2) the market portfolio? Explain why. (5 points)

e. Consider the following alternatives: (1) Invest all of your $10,000 in the Stock A and Stock B risky portfolio above or (2) invest all of your $10,000 in the risky market portfolio. Which option do you prefer? Explain why. If it depends, tell me what it depends upon. (5 points)