Use the following information to answer the two questions be

Use the following information to answer the two questions below. State of the economy Boom Bust Prob. of the Rate of return if state occurs state of econom 0.70 0.30 Stock A 0.15 0.05 Stock B 0.05 0.05 You MUST use 4 digits in every calculation you do in order for your answer to be the same as the one in the system. Enter answer using 4 decimals. What is the expected return of a portfolio with 75% in asset A and 25% in Asset B? what is the variance of the portfolio with 75% in asset A and 25% in Asset B?

Solution

Boom:

Expected Return = 75% * 0.15 + 25% * 0.05
Expected Return = 0.125

Bust:

Expected Return = 75% * -0.05 + 25% * 0.05
Expected Return = -0.025

Expected Return of Portfolio = 0.70 * 0.125 + 0.30 * (-0.025)
Expected Return of Portfolio = 0.08

Variance = 0.70 * (0.125 - 0.08)^2 + 0.30 * (-0.025 - 0.08)^2
Variance = 0.0047