You have $20,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 16 percent and Stock Y with an expected return of 11 percent. Assume your goal is to create a portfolio with an expected return of 12.65 percent. How much money will you invest in Stock X and Stock Y

Investment in stock X is $6600. Investment in stock Y is $13400

Explanation:

The expected return of a portfolio is a function of the weightage of individual stocks in a portfolio multiply by the expected returns of the individual stock that form up the portfolio. For a two stock portfolio, the formula for portfolio return is:

Return P = wX * rX + wY * rY

Where,

wA and wB is the weightage of investment in stock X and stock Y rA and rB is the expected return of stock X and stock Y

Let wX be the weight of investment in Stock X. The weight of investment in stock Y is 1-wX

0.1265 = wX * 0.16 + (1 - wX) * 0.11

0.1265 = 0.16wX + 0.11 - 0.11wX

0.1265 - 0.11 = 0.05wX

0.0165 / 0.05 = wX

wX = 0.33 or 33%

The weightage of investment in Stock X is 33%

The weightage of investment in Stock Y is (1 - 33%) = 67%

Investment in Stock X = 0.33 * 20000 = $6600

Investment in Stock Y = 0.67 * 20000 = $13400