You have invested in a portfolio of two stocks. Stock A is expected to produce a 7% return next year; the risk factor is 2.5% (standard deviation of the return). Stock B is expected to produce an 15.5% return next year; the risk factor is 8% (standard deviation of the return). Your portfolio includes 60% of Stock A and 40% of Stock B. Compute the expected return of the portfolio. Compute the standard deviation of the portfolio if the Correlation Coefficient is +1.0 Compute the standard deviation of the portfolio if the Correlation Coefficient is 0.0 Compute the standard deviation of the portfolio if the Correlation Coefficient is -1.0 Use the Standard Deviation of the Portfolio

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Q: expected return of the portfolio

A: If 60 per cent of A, 40 per cent of B   = (0.6) × (7) + (0.4 × 15.5) = 4.2 + 6.2 = 10.4

Risk and return

Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary. 

Capital Asset Pricing Model

Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.