A bank is considering adding security underwriting services to the services it offers.It has estimated that the expected return and standard deviation of its traditional service are 8% and 10% respectively.It has estimated that the expected return and standard deviation of its new securities underwriting services are 16% and 20% respectively.The correlation between these services has been estimated to be -0.3 and the bank estimates that 80% of its business will be from traditional services and 20% from the new services.What is the expected return of the new combined firm?

Question

Quizplus · Accepted Answer

To calculate the expected return of the new combined firm, we use the formula:
Expected return of combined firm = (weight of traditional service x expected return of traditional service) + (weight of new service x expected return of new service)

Weight of traditional service = 0.8
Weight of new service = 0.2
Expected return of traditional service = 8%
Expected return of new service = 16%

Expected return of combined firm = (0.8 x 8%) + (0.2 x 16%)
Expected return of combined firm = 6.4% + 3.2%
Expected return of combined firm = 9.6%

Therefore, the expected return of the new combined firm is 9.6%, which is answer choice B.

A Bank Is Considering Adding Security Underwriting Services to the Services