Merrill Finch

a. 1. The T-bill's return does not depend on the state of the economy because the U.S. Treasury must redeem the bills regardless of the state of the economy. T-Bills are not entirely riskless. This is because T-bills are comprised of real risk-free rate and an inflation premium. If the rate of inflation is greater than realized return of the T-bill, then one would actually lose money investing in a T-bill.

2. High Tech's returns are expected to move with the economy most likely because the company's sales are affected by the economy itselfÐ'--when the economy is doing well, sales increase, which increases profits, etc. All of this ultimately affects a stock's return. Collections is negatively correlated to High Tech, so it is assumed that Collections will perform in the opposite direction that High Tech does.

b. Expected Rate of Return

T-Bills: 5.5%

High Tech: 12.4%

Collections: 1.0%

U.S. Rubber: 9.8%

Market Portfolio: 10.5%

2 Stock Portfolio: 4.2%

c. 1. Std. Deviation Calculations

T.Bills

5.5-5.5=0

High Tech

-27-12.4=-39.4=1552.36

-7-12.4=-19.4=376.36

15-12.4=2.6=6.76

30-12.4=17.6=309.76

45-12.4=32.6=1062.76

=Square root of 3308=57.5%

2-Stock Portfolio

0-4.2=-4.2=17.64

7.5-4.2=3.3=10.89

12-4.2=7.8=60.84

=Square root 89.37=9.45%

2. The standard deviation measures a security's stand-alone risk. Further, the standard deviation measures the

volatility of an investment. If an investment has a large standard deviation, than there is a high probability that

the actual realized return will not meet the expected return.

d. CV

T.Bills=0/5.5=0

High Tech=57.5/12.4=4.6

The CV is a better measure of an asset's stand-alone risk than standard deviation because CV considers both the

expected value and the dispersion of a distribution.

e. 1.

2. There is less riskiness in the 2-stock portfolio compared with the riskiness of the individual stocks (if they were

held in isolation) because there is greater diversification in the 2-stock portfolio which reduces stand-alone risk.

There is less stand-alone risk in the 2-stock portfolio because High Tech and Collections are negatively

correlated.

f. 1. If an investor starts with a portfolio consisting of one randomly selected stock and adds more stocks to the portfolio, this would reduce the standard deviation of the portfolio, which essentially reduces the riskiness of the portfolio.

2. As more and more randomly selected stocks are added, this would reduce risk, so the investor would stand a better chance of not only receiving a return, but of receiving a higher expected return than if the portfolio consisted of one randomly selected stock. This implies that investors should hold a diversified portfolio that includes a number of different stocks with different risks.

g. 1. Whether or not a portfolio is properly diversified would undoubtedly impact the way that investors think about the riskiness of individual stocks. An investor would have to greatly consider a stock's stand-alone risk, as well as the standard deviation

...