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Start with asset A which has an expected return of 10% and a volatility of 30%.

1. Suppose that we introduce asset B with an expected return of 10% and a volatility of 30%. The correlation between the two asset returns is 0.9. What is the optimal combination of A and B? What is the volatility of this portfolio? [Hint: The expected return of any combination is 10%, so you want to minimize the portfolio volatility.]

2. Now suppose that we introduce asset C with an expected return of 10% and a volatility of 30%. The returns of asset C are uncorrelated with both the returns of asset A and of asset B. What is the optimal combination of A, B, and C? What is the volatility of this portfolio?

3. Did the introduction of B or C have a greater e act in decreasing the portfolio volatility? Why is this case?

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Financial Management, Finance

Category:- Financial Management
Reference No.:- M91535923

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