You decide to invest in a portfolio consisting of 15 percent Stock X, 51 percent Stock Y, and the remainder in Stock Z. Based on the following information, what is the standard deviation of your portfolio?

State of Economy Probability of State Return if State Occurs

of Economy

Stock X Stock Y Stock Z

Normal. 78 10.90% 4.30% 13.30%

Boom. 22 18.20% 26.20% 17.70%

5.70%

3.25%

8.31%

2.44%

7.13%

5.70%

Explanation:

Stock return for Normal state of economy

= 0.15 * 10.9 + 0.51 * 4.3 + 0.34 * 13.3

= 8.35%

Stock return for Boom state of economy

= 0.15 * 18.2 + 0.51 * 26.2 + 0.34 * 17.7

= 22.11%

Weighted average return

= 0.78 * 8.35 + 0.22 * 22.11

= 11.38%

Standard deviation = Normal probability state of economy * (Stock return for Normal state of economy - Weighted average return) ^number of years + Boom probability state of economy * (Stock return for Boom state of economy - Weighted average return) ^number of years) ^percentage

= 0.78 * (8.35 - 11.38) ^2 + 0.22 * (22.11 - 11.38) ^2) ^0.5

= 5.70%