If the CORR between stock are as follows
CORR(A,B)=.85
(A,C)=.60
(A,D)=.45
and expected return is 8% and standard deviation is 20% what would be the best portfolio and why?
To determine the best portfolio, we will consider the correlation and expected returns of different combinations. A portfolio is a combination of assets with varying weights assigned to each asset. In this scenario, we have four stocks: A, B, C, and D.
First, let's calculate the portfolio returns based on different weight distributions:
1. Portfolio consisting of Asset A only:
Expected Return: 8%
Standard Deviation: 20%
2. Portfolio consisting of Assets A and B:
To calculate the portfolio returns, we need to consider the weightage of each asset. Let's assume we allocate 50% of the portfolio to Asset A and the remaining 50% to Asset B.
Expected Return: (0.5 * 8%) + (0.5 * Expected Return of Asset B)
Standard Deviation: Calculated using the formula for the standard deviation of a two-asset portfolio.
3. Portfolio consisting of Assets A and C:
Similar to the previous scenario, let's allocate 50% of the portfolio to Asset A and 50% to Asset C.
Expected Return: (0.5 * 8%) + (0.5 * Expected Return of Asset C)
Standard Deviation: Calculated using the formula for the standard deviation of a two-asset portfolio.
4. Portfolio consisting of Assets A and D:
Using the same approach, allocate 50% of the portfolio to Asset A and 50% to Asset D.
Expected Return: (0.5 * 8%) + (0.5 * Expected Return of Asset D)
Standard Deviation: Calculated using the formula for the standard deviation of a two-asset portfolio.
By calculating the expected returns and standard deviations for each portfolio combination, we can compare them and determine the best portfolio.
Note: We have not provided the expected returns and standard deviations for Assets B, C, and D in your question. Please provide those figures to calculate the portfolio returns accurately.