Assume that your uncle holds just one stock, East Coast Bank (ECB), which he thi
ID: 2673004 • Letter: A
Question
Assume that your uncle holds just one stock, East Coast Bank (ECB), which he thinks has very little risk. You agree that the stock is relatively safe, but you wonder about diversification. You obtained the following return data for West Coast Bank (WCB). Both banks have had less variability than most other stocks over the past 5 years. Measured by the standard deviation of returns by how much would your uncle's risk have been changed if he had held a protfolio consisting of 60% in ECB and the remainder in WCB.Year EBB WCB
2004 40.00% 40.00%
2005 -10.00% 15.00%
2006 35.00% -5.00%
2007 -5.00% -10.00%
2008 15.00% 35.00%
Explanation / Answer
Assume that your uncle holds just one stock, East Coast Bank (ECB), which he thinks has very little risk. You agree that the stock is relatively safe, but you wonder about diversification. You obtained the following return data for West Coast Bank (WCB). Both banks have had less variability than most other stocks over the past 5 years. Measured by the standard deviation of returns by how much would your uncle's risk have been changed if he had held a protfolio consisting of 60% in ECB and the remainder in WCB.
Year EBB WCB
2004 40.00% 40.00%
2005 -10.00% 15.00%
2006 35.00% -5.00%
2007 -5.00% -10.00%
2008 15.00% 35.00%
E(e) = (40-10+35-5+15)/5 = 75/5 = 15%
E(w) = (40+15-5-10+35)/5 = 75/5 = 15%
answer =15% expected return