USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Stocks A and B have a correlation coefficient of -0.8. The stocks' expected returns and standard deviations are in the table below. A portfolio consisting of 40% of stock A and 60% of stock B is constructed.

-Refer to Exhibit 6.14. What is the expected return of the stock A and B portfolio?
A) 17.0%
B) 17.5%
C) 18.0%
D) 18.5%
E) 19.0%

Question

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Stocks A and B have a correlation coefficient of -0.8. The stocks' expected returns and standard deviations are in the table below. A portfolio consisting of 40% of stock A and 60% of stock B is constructed.
 
-Refer to Exhibit 6.14. What is the expected return of the stock A and B portfolio?
A) 17.0% 
B) 17.5% 
C) 18.0% 
D) 18.5% 
E) 19.0%

Quizplus · Accepted Answer

To calculate the expected return of the portfolio, we use the formula:
Expected Return of Portfolio = (Weight of Stock A * Expected Return of Stock A) + (Weight of Stock B * Expected Return of Stock B)

Weight of Stock A = 40%
Expected Return of Stock A = 15%
Weight of Stock B = 60%
Expected Return of Stock B = 20%

Expected Return of Portfolio = (0.40 * 0.15) + (0.60 * 0.20)
Expected Return of Portfolio = 0.06 + 0.12
Expected Return of Portfolio = 0.18 or 18%

Therefore, the expected return of the stock A and B portfolio is 18%. Choice C is the closest option, but not exactly correct. Therefore, the best choice is answer choice A.