SCENARIO: You are bullish on company ABC and company XYZ. Suppose you have $2 million to invest.

SCENARIOYou are bullish on company ABC and company XYZ. Suppose you have $2 million to invest.You consider four different investment strategies in the form of portfolios:Note that we assume the variances of ABC and XYZ are similar (say within 20% of each other)AND positively correlated.Portfolio ABuy $1 million worth of ABC stock using cash.Buy $1 million worth of XYZ stocks using cash.Portfolio BBuy $2 million worth of ABC stock using $1 million and borrowing $1 million.Buy $2 million worth of XYZ stock using $1 million and borrowing $1 million.Portfolio CBuy call options on ABC stock expiring in 1 month, with strike $5 higher than ABC's stockprice. The cost of all these ABC options is not more than $500,000.Buy call options on XYZ expiring in 1 month, with strike $5 higher than XYZ's stock price.The cost of all these XYZ options is not more than $500,000.Portfolio DSell put options on ABC expiring in 1 month, with strike $5 lower than ABC's stock price.Sell put options on XYZ expiring in 1 month, with strike $5 lower than XYZs' stock price.**NOTE: **Questions 5 and 6 are **not **based on this scenario.Question 1: Which portfolio(s) are affected by higher-than-expected covariance? Give at least 2reasons.Question 2: What happens to the option portfolios if the correlation between ABC and XYZ is 0?Describe effects on return and risk.Question 3: Excluding Portfolio D, which portfolio(s) has the potential to make more than100%? Give at least 2 reasons.Question 4: For proper risk management, which of the portfolios should be hedged? Give at least2 reasons.Question 5: What happens when you have both high volatility AND high correlation? Provide atleast 2 arguments.Question 6: Which of the portfolios have a non-linear payoff? Give at least 2 reasons.