A portfolio has 25% of its funds invested in Security C and 75% of its funds invested in Security D. Security C has an expected return of 8% and a standard deviation of 6%. Security D has an expected return of 10% and a standard deviation of 10%. The securities have a coefficient of correlation of 0.6. Which of the following values is closest to portfolio return and variance?
A) .090; .0081
B) .095; .001675
C) .095; .0072
D) .100; .00849
E) Cannot calculate without the number of covariance terms.

Question

Quizplus · Accepted Answer

The portfolio expected return is calculated as the weighted average of the expected returns of the securities:

Portfolio expected return = (0.25 x 8%) + (0.75 x 10%) = 9.5%

The portfolio variance is calculated as follows:

Portfolio variance = (0.25^2 x 6%^2) + (0.75^2 x 10%^2) + 2 x 0.25 x 0.75 x 6% x 10% x 0.6

= 0.0018 + 0.005625 + 0.00135 = 0.008775

Therefore, the closest values to portfolio return and variance are 9.5% and 0.0072, respectively, which corresponds to choice letter C.

A Portfolio Has 25% of Its Funds Invested in Security