Exercise 2 (3 points)
Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 15% and a standard deviation of 18%. B has an expected rate of return of 8% and a standard deviation of 12%.
Can you build a risk free portfolio using only these two assets? Explain you answer.
Yes. We can use these two assets which are perfectly negatively correlated in order to totally eliminate portfolio risk.
If yes, find the composition of the above portfolio, its return and its volatility?
risk-free portfolio => P=0=> EP=EM=> Variance of portfolio = 0
=> (0.18 xA - 0.12 xB)^2 = 0 (since correlation between A and B is -1)
We also have xA + xB = 1
=> xA = 40%
xB = 60%
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