Consider two shares, A and B, with a given return of 8 % and 4 %. The risks are given by 6 % for A and 3 % for B. The covariance of the two returns of the two shares is given by ‑0.00144. The portfolio of the two shares consists of 30 % of share A and 70 % of share B. The standard deviation of the portfolio´s return is equal to
A. 2.45 %
B. 3.63 %
C. 1.27 %
Solution: C. is correct.
We compute the variance as
variance_portfolio
= (w_A)^2*Var_A + (w_B)^2*Var_B + 2*(w_A)*(w_B)*Cov_(A,B)
= 0.3^2*0.06^2 + 0.7^2*0.03^2 + 2*0.3*0.7*(-0.00144)
= 0.0001602, leading to a standard deviation of 1.27 %.
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