Question Stocks A and B have the following historical returns: Year Stock A return Stock B return 2004 (24.25%) 5.5% 2005 18.5% 26.73% 2006 38.67% 48.25% 2007 14.33% (4.5%) 2008 39.13% 43.86%...

Question

Stocks A and B have the following historical returns:

1. Calculate the average rate of return for each stock during the period 2004 through 2008. Assume that someone held a portfolio consisting of 50% of Stock A and 50% of Stock. What would the realized rate of return on the portfolio have been in each year from 2004 through 2008? What would the average return on the portfolio have been during that period?


2. Calculate the standard deviation of returns for each stock and for the portfolio.


3. Looking at the annual returns on the two stocks, would you guess that the correlation coefficient between the two stocks is closer to +0.8 or to –0.8?


4. If more randomly selected stocks had been included in the portfolio, which of the following is the most accurate statement of what would have happened to p?

a. p would have remained constant.

b. p would have been in the vicinity of 20%.

c. p would have declined to zero if enough stocks had been included.