An analyst is examining the following two-stock portfolio: Stock Portfolio Weigh

Question

An analyst is examining the following two-stock portfolio:

Stock             Portfolio Weight               Expected Return              Standard Deviation

Stock X             .30                                   18%                                 35%
Stock Y             .70                                   11%                                 35%

What is the portfolio's expected return?

13.1%
14.15%
13.8%
15.2%
16.25%

If randomly selected stocks are added to the portfolio until the portfolio has no asset-specific risk remaining, which of the following is the best estimate of the portfolio's standard deviation of returns?

0%
50%
20%
35%
70%

The tradeoff between risk and return is a cornerstone concept in finance. If a security offers a higher expected return, it must have higher risk. Look at the two stocks described in this problem. They have the same risk, but one stock has a higher expected return. Does this example contradict the tradeoff between risk and return?

Yes
No

Explanation / Answer

Expected return on the portfolio = 0.3*18% + 0.7*11%

expected return on the portfolio = 13.10%

standard deviation = 0.7*35% + 0.3*35% = 35%

yes since A has higher return for the same risk offered by B

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