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Consider two stocks A and B with returns ra and rb such that E(ra)=9%, E(rb)=15%,...

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Finance

Consider two stocks A and B with returns ra and rb such that E(ra)=9%, E(rb)=15%, sa=10%, and sb=19%.

Construct portfolios of the two stocks by investing fraction y in stock A and (1-y) in stock B, i.e., P=yA+(1-y)B. For the following four cases, vary weight y and plot the resulting portfolios expected return E(rP) vs. its standard deviation sP.

a) corr(ra, rb)=1.0;

b) corr(ra, rb)=0.5;

c) corr(ra, rb)=0.0;

d) corr(ra, rb)=-1.0;

Put all these graphs on the same plot. Choose increment and range for weight y to make the plot look pretty (for example, from 1 to 3 with increment 0.05).

Hint: when plotting graphs in Microsoft Excel, choose type of chart as XY(Scatter) and draw four graphs (or series). For Y-axis, use the expected return E(rP) (same for all four graphs); for X-axis, use the standard deviation sP (corresponding to four different values of correlation coefficient).

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