Bab 12-Risk and Diversification
You are considering an investment in the stock market and have identified two potential
stocks (XYZ and ABC) to purchase. The historical return for the past five years shown in
the table below:
Year
2000
2001
2002
2003
2004
XYZ Return
11%
15%
21%
9%
13%
ABC Return
25%
12%
19%
13%
8%
a. Calculate the average return and standard deviation of return for each stock over
the past five years. Based on this information alone, which stock would you prefer
to own? Would everybody make the same choice?
b. Calculate the correlation coefficient between the two stocks. Does it appear that a
portfolio consisting of XYZ and ABC would provide good diversification?
c. Calculate the annual return that would have been achieved had you owned a
portfolio consisting of 50% in XYZ and 50% in ABC over the past five years.
d. Create a chart that shows how the standard deviation of the portfolio’s return
changes as the weight of XYZ changes.