Following is the data regarding six securities: U V W X Y Z Return (%) 10 10 15 5 11 10 Risk (%) (Standard deviation) 5 6 13 5 6 7 (i) Recommend at…

(i) When we make risk-return analysis of different securities from U to Z, we can observe that security U gives a return of 10% at risk level of 5%. Simultaneously securities V and Z give the same return of 10% as of security U, but their risk levels are 6% and 7% respectively. Security X is giving only 5% return for the risk rate of 5%. Hence, security U dominates securities V, X and Z. Securities W and Y offer more return but it carries higher level of risk. Hence securities U, W and Y can be selected based on individual preferences. (ii) In a situation where the perfect positive correlation exists between two securities, their risk and return can be averaged with the proportion. Assuming the perfect correlation exists between the securities U and W, average risk and return of U and W together for proportion 4 : 1 is calculated as follows: Risk = (4 × 5% + 1 × 13%) ÷ 5 = 6.6% Return = (4 × 10% + 1 × 15%) ÷ 5 = 11% Therefore: 80% U 20% V 100%Y Risk 6.6% 6% Return 11% 11% When we compare risk of 6.6% and return of 11% with security Y with 6% risk and 11% return, security Y is preferable over the portfolio of securities U and W in proportion of 4 : 1.