You have been given the following information about the random distributions on two risky investments, Shares A and B, whose returns are dependent on the level of economic growth:

State of Economy Probability of Return on A if Return on B if

economic state economic state economic state

occurs (%) occurs (%)

Boom 0.30 30 20

Growth 0.50 20 12

Recession 0.20 -10 -6

(a) Calculate the expected return and standard deviation for both shares.

10 marks

(b) Calculate the covariance between returns on A and returns on B.

10 marks

(c) Calculate the correlation of coefficient between returns on A and returns on B.

10 marks

(d) Determine a portfolio expected return and standard deviation if half of a fund is devoted to A and half devoted to B.

10 marks

(e) Briefly outline why investors who fail to diversify their holdings should not be compensated for the additional risk they face.