8006 Exam Dumps | A and B are two stocks with normally distributed returns. The returns for stock A have a mean of 5% and

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Exam I: Finance Theory Financial Instruments Financial Markets - 2015 Edition
PRMIA.8006.v2021-04-25.q101
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Question 5/101

A and B are two stocks with normally distributed returns. The returns for stock A have a mean of 5% and a standard deviation of 20%. Stock B has a mean of 3% and standard deviation of 5%. Their correlation is -0.6.
What is the mean and volatility of a portfolio which holds stocks A and B in the ratio 6:4?

A. 4.2% and 14%

B. 4% and 10.92%

C. 4.2% and 10.92%

D. 4.2% and 1.19%

Correct Answer: C

Explanation
The mean can be calculated quite easily as a weighted average, and in this case it is 0.6*5% + 0.4*3% = 4.2%.
The variance can be calculated with the formula for portfolio variance as = (0.6^2)*(20%^2) + (0.4^2)*(5%^2)
+ 2*(-0.6)*0.6*0.4*20%*5%=0.01192. Therefore the volatility of this portfolio is SQRT(0.01192)=10.92%

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