Reference no: EM133116106

The expected rate of return of A stock is 30% and the standard deviation of the returns is 22%, while the expected rate of return of B stock is 18% and the standard deviation of the returns is 15%. The correlation between the returns of A and B shares is 0.40 and the risk-free rate of return of T-bills is 3%. The FTSE100 index has a rate of return of 15% during the same period.

Part A). Calculate the expected return and standard deviation of an equally-weighted portfolio containing stocks A and B.

Part B). A risk manager assumes that the joint distribution of returns is multivariate normal and calculates the following risk measures for a two-asset portfolio:

If asset B is dropped from the portfolio, what is the reduction in portfolio Value at Risk (VaR)?

Part C). What are  and  relative to the portfolio?

Part D). A small investment management firm measures absolute risk with a 99%, one-year VaR, which gives -£1.5 million. The firm wants to allocate this risk to two portfolio managers, each with the same VaR budget. Given that the correlation between managers is -0.7, the VaR budget for each should be?