The management of Gawain plc is evaluating two projects whose returns depend on the future state of the economy as shown below:
The project (or projects) accepted would double the size of Gawain.
Required
(a) Explain how a portfolio should be constructed to produce an expected return of 20 per cent.
(b) Calculate the correlation between projects A and B, and assess the degree of risk of the portfolio in (a).
(c) Gawain’s existing activities have a standard deviation of 10 per cent. How does the addition of the portfolio analysed in (a) and (b) affect risk?