Question

Suppose Intel’s stock has an expected return of 26% and a volatility of 50%, while Coca-Cola’s has an
expected return of 6% and volatility of 25%. If these two stocks were perfectly negatively correlated
(i.e., their correlation coefficient is −1),
a. Calculate the portfolio weights that remove all risk.
b. If there are no arbitrage opportunities, what is the risk-free rate of interest in this economy?
a. If the two stocks are perfectly correlated negatively, they fluctuate due to the same risks, but in
opposite directions. Because Intel is twice as volatile as Coke, we will need to hold twice as
much Coke stock as Intel in order to offset Intel’s risk. That is, our portfolio should be 2/3 Coke
and 1/3 Intel.

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

Cell reference -

Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.