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Question 2
Suppose that there exist two securities (A and B) with annual expected returns equal to = 3% and =
5% and standard deviations equal to = 7% and = 10% respectively. The correlation coefficient
between the returns of these securities is = 0.5.
2.1 What is the expected return and the standard deviation of an equally weighted portfolio consisting
of the securities A and B? Describe every step of your calculations in detail.
(15%)
2.2 What is the expected return and the standard deviation of a portfolio consisting of the securities A
and B, if the relevant weights are chosen to minimize the risk of the portfolio? Present the
minimisation problem and describe every step of your calculations in detail.
(20%)
2.3 How could an investor maximize diversification benefits? Critically discuss and explain in detail.
(15%)
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