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Question 1 a. The expected return and standard deviation of return on two stocks are given below, together with the correlation coefficient. Expected Return (%) Standard Deviation (%) Stock 1 11 18 Stock 2 10 13 Correlation = -1 Suppose that it is possible to borrow at the risk-free rate Fr . What must the value of the risk-free rate be? Explain and show all your workings. (8 marks) b. If you were to combine Stock 1 and Stock 2 from a) into various portfolios, what would be the shape of the efficient frontier on which those portfolios would plot? Explain. (4 marks) c. Under which circumstances is the two-asset portfolio standard deviation equal to the weighted average of standard deviations of its assets? Explain, using equally weighted portfolio where two assets have equal variances as an example. (5 marks) d. “The more stocks in a portfolio, the greater degree of diversification”. Is this statement always true, only sometimes true or never true? Justify your answer, explaining the impact of the number of stocks on portfolio diversification. (8 marks)