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2. You have the choice of investing in four assets. The expected returns, volatility of...

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2. You have the choice of investing in four assets. The expected returns, volatility of retums and correlation coefficients of retums are listed in the table below: CORRELATION MATRIX Asset Class Return (%) Volatility (%) Stocks Bonds Real Estate T-Bills Stocks 5 3 1.00 0.25 -0.39 -0.16 Bonds 0.01 1 0.25 1.00 -0.87 -0.11 Real Estate -3 2 -0.37 -0.22 1.00 0.90 T.Bills 3.45 0 -0.16 -0.87 1.00 0.90 QUESTION 2 CONTINUED (1) There are two errors in the correlation matrix provided. Find and correct them to the proper correla- tion numbers (HINT: choose the smaller correlation figure for both items). (2 MARKS) (ti) Explain why the correlation matrix had those two errors. (3 MARKS) b) Calculate: (1) The expected return for a portfolio (named Portfolio A) which is equally weighted and for a portfo- lio (called Portfolio B) that has 70% holdings in stocks; 10% in real estate with an equal spread allo- cated to the fixed income assets. (4 MARKS) (ii) The variance and standard deviation of returns for Portfolio A and Portfolio B. (10 MARKS) c) Comment on the scale of risk reduction between the two portfolios. What would you say is the signifi- cant reason why volatility is reduced? (6 MARKS)

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