Please consider the following stocks:
Price per Expected Standard
Stock Share Return Deviation Correlation
A $25 0.06 0.20 With B = 0.20
B $50 0.08 0.10 With C = 0.45
C $25 0.15 0.15 With A = 0.60
An investor has a $10,000 portfolio that is allocated as follows: short 100 shares of stock A, buy 250 shares of B and 200 shares of 3. Any additional funds are borrowed or lent at the risk free rate of 0.04.
Stock B can be replaced with one of two stocks : Stock D - expected return 0.15, standard deviation of 0.15 and zero correlation with all other stocks. Stocks E - also has zero correlation with all other stock while it has an expected return of 0.09 and a standard deviation of 0.11. Would you recommend a replacement for stock B and which of the possible replacements would you choose?
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The solution answers a question on replacement of stocks in a portfolio.