Stocks A and B each have an expected return of 12%,a beta of 1.2,and a standard deviation of 25%.The returns on the two stocks have a correlation of 0.6.Portfolio P has 50% in Stock A and 50% in Stock B.Which of the following statements is correct?
A)Portfolio P has a beta that is greater than 1.2.
B)Portfolio P has a standard deviation that is greater than 25%.
C)Portfolio P has a standard deviation that is less than 25%.
D)Portfolio P has a beta that is less than 1.2.

Question

Quizplus · Accepted Answer

Since Stocks A and B have the same beta and standard deviation, and their returns are not perfectly correlated (correlation less than 1), diversification will lead to a portfolio (Portfolio P) with a standard deviation less than the individual stocks' standard deviation of 25%. The beta of the portfolio will be the average of the betas of the stocks in it, which remains 1.2, since both stocks have a beta of 1.2.

Stocks a and B Each Have an Expected Return of 12%,a