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Calculate the Standard Deviation of a Two-stock Portfolio

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Let X and Y be two stocks with the following features:

- Stock X Expected Return 14%
- Stock Y Expected Return 18%
- Stock X Standard Deviation 40%
- Stock Y Standard Deviation 54%
- Correlation(X,Y) = .25
- Mean is 15.6%

What is the standard deviation for a portfolio with 60% in stock x and 40% invested in stock Y?

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Solution Summary

The solution carefully explains all the concepts, the logic while showing the formulas and the calculations to arrive at the answers.

Solution Preview

The formulas used to compute the answer are the following.

Let X and Y be random variables, and let a and b be numbers. Then,

1) Var(X) = SD(X)^2 (SD is standard deviation)

2) Var(aX+bY)=a^2*Var(X)+b^2*Var(Y)+2*a*b*Cov(X,Y) (Cov is covariance)

3) Correlation(X,Y)= Cov(X,Y)
-------------
SD(X)*SD(Y)

In ...

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