Abigail Grace has a $800,000 fully invested original portfolio. She subsequently inherits ABC Company common stock worth $200,000. Her financial adviser provided her with the following estimates.
Current ValueExpected ReturnStandard Deviation
Original Portfolio$800,00010%20%
ABC Company$200,00014%50%
1) If the correlation coefficient of ABC stock returns with the original portfolio return is 0.5, what is thestandard deviation of her new portfolio which includes the ABC stock?
2) Based on conversations with her husband, Grace is considering replacing the $200,000 of ABC stock with $200,000 of XYZ stock instead. XYZ stock has the same expected return and the same standard deviation as ABC stock. If the correlation of XYZ stock returns with the original portfolio return will be -0.2, what is the expected return of her new overall portfolio?
3) Based on the information given above, which overall portfolio (original portfolio+ ABC stock OR original portfolio+XYZ stock) is preferred?
