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QUESTION A
The Bank of Tinytown has three loans that have the following characteristics but only needs to select two loans to include in their portfolio. If the covariance between A and C is approximately 0.100 and the covariance between Loan B and Loan C is approximately 0.065, what are the expected return and standard deviation of this portfolio? Given the covariances, can the calculation be simplified? What will the risk of the portfolio be, given the simplification?
Loan Size ($ millions)
Return (%)
Variance (%)
Loan A
$ 500.0
11.0
10.65
Loan B
$ 1,600.0
7.50
5.25
Loan C
$ 800.0
12.5
9.75
QUESTION B
Briefly describe any way(s) that the risk of this portfolio may be reduced? Be specific and show calculations.
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