You are planning to create an investment portfolio. You are evaluating two stocks. Table below show the anticipated returns on the stocks in under different scenarios. Returns (%) State of economy Probability Stock A Stock B Boom 0.2 20 Normal 0.5 11 Recession -5 10 12 0.3 15 Required: 1. Computed the expected return for each stock. [3+3 marks] 2. Compute the standard deviation of returns on the stocks. [3+3 marks] 3. Compute the correlation coefficient between returns of stocks A and B. [3 marks] 4. You are not sure how much to allocate funds between these two stocks in your portfolio. Therefore, we want to know the risk and return of portfolios formed by mixing these two stocks in varying proportions. Now compute the expected return and standard deviation of portfolio formed in the following proportions. Portfolio Portfolios Expected Return Standard Deviation Portfolio Weights Weight on Weight on Stock A Stock B 0.00 1.00 0.25 0.75 0.50 0.50 1 ? ? 2 ? ? 3 ? ? 4 0.75 0.25 ? ? 5 1.00 0.00 ? ? (Hints: See Table 11.9 (page#363) and related texts for reference; formula for portfolio standard deviation can be found in page#366, although there are many ways to compute portfolio standard deviation. Only for this part of the question you can use excel and provide required answers, i.e. you don't need to show me intermediate calculations). 5. Among 5 potential portfolios, which one would you choose and why? [3 marks] (Hints: You may try to depict figure like Figure 11.5 in page#364 from your answers in part d and write your answer; note that figure/drawing is not required to submit with the answer; though I encourage you to draw and submit with the answer!). Correlation between x and y, Pxy covariance between x and y standard deviation of x x standard deviation of y FIGURE 11.5 The investment opportunity frontier for the gold and auto stocks. Each point on the curve represents a feasible combination of expected return and volatility. The six labelled points correspond to the portfolios in & Table 11.9. A 01 Expected return (%) E F 5 10 15 20 Standard deviation (%)