CMA Final · Strategic Financial Management · Portfolio Theory and Practice
A portfolio has 50% in Asset P (expected return 12%, SD 15%) and 50% in Asset Q (expected return 8%, SD 25%). Correlation is zero. What is the portfolio expected return and SD?
Expected return is 10% and standard deviation is 14.58%. With zero correlation the variance is 0.25x225 plus 0.25x625, which is 212.5, and its square root is 14.58%. Averaging the SDs to get 20% would ignore diversification.
- A10%; 14.58%Correct
- B10%; 20.00%
- C10%; 11.67%
- D10%; 10.00%
Explanation
Expected return = 0.5x12 + 0.5x8 = 10%. Variance = 0.25x225 + 0.25x625 = 56.25 + 156.25 = 212.5. SD = sqrt(212.5) = 14.58%. Taking the simple average of SDs (20%) ignores diversification.
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