Problem: Consider two stocks, A and B, with the following expected returns and standard deviations.
Expected Standard
Return Deviation
A 8.00% 20.00%
B 12.00% 30.00%
The correlation coefficient between the returns of A and B is 0.3. Short selling is allowed.
a. Consider a portfolio, P, that comprises 45% invested in stock A and 55% invested in stock B. What is the expected return, standard deviation and coefficient of variation of P?
b. Plot A and B in expected return-standard deviation space and draw (approximately) the feasible set for P. On this diagram, mark the minimum variance portfolio and the efficient set.
c. Draw (approximately) the feasible set, minimum-variance portfolio and efficient set when the correlation coefficient between A and B is (a) -1 and (b) +1.
d. Suppose that the correlation coefficient between A and B was -1. What are the weights of the minimum variance portfolio?
e. What would the risk free rate be if the correlation coefficient between A and B is -1?