THE NEXT QUESTIONS ARE BASED ON THE FOLLOWING INFORMATION:
Investment A has an expected return of 8% with a standard deviation of 2.5%.Investment B has an expected return of 6% with a standard deviation of 1.2%.Assume you invest equally in both investments and that the rates of return are independent.
-What is the expected return of your portfolio?
A)8%
B)7%
C)6%
D)4%

Question

Quizplus · Accepted Answer

The expected return of the portfolio is the weighted average of the expected returns of the individual investments. Since both investments have equal weight and expected returns of 8% and 6%, respectively, the expected return of the portfolio is (0.5 x 8%) + (0.5 x 6%) = 7%.

Investment B is the better choice as it has a higher return per unit of risk. This is measured by the Sharpe ratio, which is calculated as (expected return - risk-free rate)/standard deviation. Assuming a risk-free rate of 2%, the Sharpe ratio of Investment A is (8% - 2%)/2.5% = 2.4, while the Sharpe ratio of Investment B is (6% - 2%)/1.2% = 3.3. Therefore, Investment B has a higher Sharpe ratio and is a better choice.