Question

John is considering forming a portfolio with two stocks, A and B. He decides to invest 40% and 60% of his money in Stock A and Stock B respectively. The expected returns over the next four years, 2013-2016, for the two stocks, are as follows:

a Calculate the expected return and the standard deviation of expected return on Stock A over the four-year period.

b Calculate the expected return and the standard deviation of expected return on Stock B over the four-year period.

c Calculate the expected return of the portfolio and the standard deviation of expected portfolio return over the four-year period.

d Is there any benefit of diversification achieved through creation of the portfolio? Why or why not? How would you characterise the correlation between the returns of the two stocks?