You have decided to invest 10,000 of your lottery winnings in a 2 asset portfolio in the following proportions:

	Security A	Security B
Expected return on security ri	20%	15%
Standard deviation of returns si	9%	7%
Amount invested	6000	4000
Proportion invested	0.6	0.4

Assume perfect negative correlation between asset returns.

Calculate:

(a) The expected return on the portfolio. (b) The portfolio risk.

How would the expected return and portfolio risk change if third security is also added to the portfolio? Assume the following additional information:

Expected return on security C: 25%

Standard deviation on return: 12%

Amount invested:5000 (total 15,000):

Proportion invested: A: 40%; B 33.33%, C = 26.67&

Remark:

(1) The correlation coefficient is a relative measure of

covariability between 2 variables. The

coefficient of correlation between the expected returns on 2 assets is given by the formula:

Cov_AB

R = ---------------------------------

s_As_B

(2) The risk of a 2-asset portfolio is given by the standard deviation of the portfolio.

(c) Explain the concept of Efficiency Frontier and how does it help taking a decision in complex network of shares and its correlation coefficients.