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5. Suppose that you have the opportunity to buy stock in AT&T and Microsoft.

AT&T Microsoft

Mean .10 .21

Standard Deviation .15 .25

a. What is the minimum risk (variance) portfolio of AT&T and Microsoft if the correlation between the two stocks is 0? .5? 1? -1? What do you notice about the change in the locations between AT&T and Microsoft as their correlation moves from -1 to 0 to .5 to +1? Why might this be?

b. What is the variance of each of the minimum-variance portfolios in part a?

c. What is the optimal combination of these two securities in a portfolio for each value of correlation, assuming the existence of a money market fund that currently weights for the minimum-variance portfolios?

d. What is the variance of each of the optimal portfolios?

e. What is the expected return of each of the optimal portfolios?

f. Derive the risk-reward trade-off line for the o[optimal portfolio when the correlation is .5. How much extra expected return can you anticipate if you take on a extra unit risk?

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