Total variance of the investment as investment risk

Reference no: EM1389503

A stockbroker, Mr. Smith, has just received a call from Mrs. Hardy, who wants to invest $50,000 in two stocks. Stock 1 is a solid blue-chip security with a respectable growth potential and little risk involved. Stock 2 is much more speculative, and according to two investment newsletters, it has an outstanding growth potential, but is also considered very risky. Mrs. Hardy would like a minimum of 30% total expected return in one year, with the smallest possible investment risk. So, she asked Mr. Smith to find a convenient mix of investments in the two stocks for her. Current price per share is 20 for stock 1 and 30 for stock 2. After doing some research, Mr. Smith estimated the expected return in one year per share to be to be 5 for stock 1 and 10 for stock 2. The variance of the return per share is 4 for stock 1 and 100 for stock 2. The covariance of the return between the two stocks is 5 per share. Use the total variance of the investment as investment risk.

A) Formulate the problem.

B) Is there a solution to it?

C) If there is no solution, what should Mr. Smith recommend to Mrs. Hardy?

D) If there is a solution, is Mr. Smith expected return estimation a concern?

Reference no: EM1389503

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