Reference no: EM132920487

You are given the following information on Aardvark (A) Inc, Bandicoot (B) Inc and the TSX market portfolio, under 5 different economic conditions. Aardvark Inc has a correlation with the market portfolio of 0.9 and Bandicoot Inc has a correlation with the market portfolio of -0.5. The TSX market portfolio has a standard deviation of 10%. The government of Canada T-bill is yielding a return of 4%.

State of the Economy Probability Return on A Return on B Boom 0.3 30% 8%

Improving 0.2 20% 8%

No change 0.2 10% 10%

Slowdown 0.2 0% 12%

Recession 0.1 -20% 15%

a) Calculate the expected return for Aardvark Inc.

b) If the expected return for Bandicoot Inc is 9.9%, calculate the standard deviation for Bandicoot.

c) Calculate the correlation between the two stocks. Assume risk for Aardvark is 15.52%.

d) Assume you have a portfolio with $40,000 invested in Aarkvard and $160,000 invested in Bandicoot. Determine the expected return and standard deviation of returns for this portfolio.

e) How well does diversification work in this scenario? How much risk reduction have you achieved from the worst-case outcome? Comment.