Let's say that there are 2 securities we are considering for purchase. Here are their returns:
|
Expectation for Return
|
Probability of Outcome
|
Return on Security A
|
Return on Security B
|
|
Optimistic
|
.15
|
.25
|
.10
|
|
Slightly positive
|
.35
|
.20
|
.15
|
|
Slightly negative
|
.35
|
.15
|
.20
|
|
Pessimistic
|
.15
|
.10
|
.25
|
a) What are the expected return and standard deviation of each security?
b) What are the expected return and standard deviation of a portfolio with half of its funds invested in each of these securities?
c) How does this explain diversification?