Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. You have a portfolio that consists of 50% A and 50% B. Which of the following statements is CORRECT?
A) The portfolio's beta is less than 1.2.
B) The portfolio's expected return is 15%.
C) The portfolio's standard deviation is greater than 20%.
D) The portfolio's beta is greater than 1.2.

Question

Quizplus · Accepted Answer

The portfolio's expected return is simply the weighted average of the expected returns of stocks A and B, so it is also 15%. Since the correlation coefficient between the returns on the two stocks is positive but not equal to 1, holding a portfolio that includes both stocks will reduce the portfolio's overall standard deviation compared to holding just one of the stocks. Therefore, the portfolio's standard deviation is less than the standard deviation of either A or B. Since the portfolio is a weighted average of the two stocks and both have the same beta, the portfolio's beta will also be 1.2.

Stocks a and B Each Have an Expected Return of 15