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Problem 6.27

David is going to purchase two stocks to form the initial holdings in his portfolio. Iron stock has an expected return of 21 percent, while Copper stock has an expected return of 15 percent.

1. If David plans to invest 30 percent of his funds in Iron and the remainder in Copper, what will be the expected return from his portfolio? (Round your answer to 1 decimal place, e.g., 17.5%.)

Expected return: _____%

2. What would the expected return of David's portfolio be if he invested 70 percent of his funds in Iron stock? (Round your answer to 1 decimal place, e.g., 17.5%.)

Expected return: _____%

Answer :

Final answer:

The expected return on David's portfolio is 16.8% when allocating 30% of his funds to Iron and 70% to Copper, and 19.2% when switching these allocations.

Explanation:

The question asks for the expected return on David's portfolio for two different investment allocations in Iron and Copper stocks. To calculate the expected return of a portfolio, we use a weighted average of the expected returns of the individual investments, with the investment amounts as the weights.

For the first scenario where 30% of his funds is in Iron and the remainder in Copper, David's portfolio's expected return would be computed as follows: (0.30 * 21%) + (0.70 * 15%) = 6.3% + 10.5% = 16.8%.

If David decided to put 70% of his funds into Iron and the remainder into Copper, the expected return of his portfolio would be: (0.70 * 21%) + (0.30 * 15%) = 14.7% + 4.5% = 19.2%.

Note: Always review your investment plan and consider the potential risks involved when investing in individual stocks, as mentioned in the provided passage. Higher potential returns often come with higher risk.

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Rewritten by : Barada

Answer:

a. 16.8%

b. 19.2%

Explanation:

The computation of the expectation return is shown below:

1. If 30% is invested:

= Iron Return × Probability + Copper return × Probability

= 21 × 30% + 15 × 70%

= 6.3% + 10.5%

= 16.8%

The remaining 70% is allocated to the copper

2. If 70% is invested:

= Iron Return × Probability + Copper return × Probability

= 21 × 70% + 15 × 30%

= 14.7% + 4.5%

= 19.2%

The remaining 30% is allocated to the copper