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Cailin Chen Question 9: (10 Points)

The document contains solutions to three investment portfolio questions. For question 1, the portfolio beta is calculated to be 1.125, meaning the portfolio is riskier than the market. Question 2 calculates the expected return, variance, and standard deviation of a two-asset portfolio. Question 3 calculates the average return, variance, and standard deviation of stock returns for Company X from 2009-2013.

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74 views5 pages

Cailin Chen Question 9: (10 Points)

The document contains solutions to three investment portfolio questions. For question 1, the portfolio beta is calculated to be 1.125, meaning the portfolio is riskier than the market. Question 2 calculates the expected return, variance, and standard deviation of a two-asset portfolio. Question 3 calculates the average return, variance, and standard deviation of stock returns for Company X from 2009-2013.

Uploaded by

Manuel Boahen
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Cailin Chen

Question 9: (10 Points)


1. A portfolio consists of the following securities:

Std.
Beta
Security Amount Invested Dev.
βi
σi

A $250,000 15.50 1.45

B $350,000 8.35 0.75

C $200,000 21.22 1.85

D $150,000 7.75 0.45

E $50,000 13.75 1.25

What is the portfolio’s beta? Is the portfolio riskier than the market? Explain.
2. An investor’s portfolio two risky-asset portfolio is allocated as follows:

Asset Type Amount Invested Standard Deviation Expected Return

Bonds $45,000 15% 6.5%

Stocks $55,000 22% 14.0%

The correlation coefficient between the two assets is zero (ρ b, s = 0). Based on this
information, calculate the portfolio’s variance of returns (σ2p), standard deviation (σp), and
expected return E (Rp).
3. The realized returns for the common stock of Company X are given as follows:

2009 2010 2011 2012 2013

5.3% 15.5% -35.0% 25.2% 12.7%


Based on this information calculate the stock’s average return, variance of returns, and
standard deviation.
Portfolio beta solution 1:

It is computed in a tabular form with formulas:

Std.
Amount Dev. Beta Weights= invest/total Porfolio beta(weights*
Security Invested σi βi investment beta)

A $250,000 15.5 1.45 0.25 0.3625

B $350,000 8.35 0.75 0.35 0.2625

C $200,000 21.22 1.85 0.2 0.37

D $150,000 7.75 0.45 0.15 0.0675

E $50,000 13.75 1.25 0.05 0.0625

$1,000,000 Porfolio beta 1.125

The portfolio is riskier to market as the portfolio beta is more than 1 .Higher the beat higher the
risk of the portfolio

Solution 2:

Amount Standard Variance


Asset Investe Deviatio Expecte WEight Expecte Differenc = square
Type d n d Return s d return e Square *prob

Bond 0001701562 $0.0007


s $45,000 15% 6.50% $0.45 $0.03 -$0.04 5 7

Stock 0001139062 $0.0006


s $55,000 22% 14.00% $0.55 $0.08 $0.03 5 3
Portfolio $0.0013
$0.11 variance 9

To compute the portfolio S.D = weight ^2 * variance ^2 + weight^2 * variance ^2 + 2* (0)


because correlation is zero

= .45^2 *.00077^2 + .55^2 *.00063^2

= .00024

Solution 3:

Year return Difference Square

2009 5.30% 0.56% 0.0031%

2010 15.50% 10.76% 1.1578%

2011 -35.00% -39.74% 15.7927%

2012 25.20% 20.46% 4.1861%

2013 12.70% 7.96% 0.6336%

Average return 0.0474 Variance 21.7733%

S.d = SQRT variance / n-1

= SQRT (.0544)

S.D = .233

Question 10: (10 Points)


1. Use the following scenario analysis for Stocks X and Y:

Scenario Description Probability of Expected Expected


Occurrence Outcome (HPR) Outcome (HPR)
Stock X Stock Y

1 Bear Market .25 -5.5% -10.5%

2 Normal Market .45 6.0% 8.0%

3 Bull Market .30 11.5% 18.5%

Based on this information:


a. Calculate the expected returns for Stocks X and Y.
b. Calculate the standard deviations of returns on Stocks X and Y.
c. Which stock is riskier? Explain your answer. Hint: You may want to interpret and compare the
standard deviation for each stock.
d. Assume that 90% of your $100,000 portfolio is invested in Stock X, while the rest (or 10%) is
invested in Stock Y. What is the expected return of your portfolio?
2. Use the CAPM to calculate the required rate of return (expected return) to Stock X if: the risk-
free rate of return is 4%, the expected return of the market is 12% and the stock’s beta
coefficient is 1.25. What is the stock’s alpha if its actual return was 12.5%? Is the stock
overpriced or underpriced? Explain.
a.Expected returns for Stocks X and Y.

Stock X E(R ) = (0.25*-0.055)+(0.45*0.06)+(0.3*0.115) = -0.01375+0.027+0.0345 = 0.04775 or


4.775%

Stock Y E(R ) = (0.25*-0.105)+(0.45*0.08)+(0.3*0.185) = -0.02625+0.036+0.0555 = 0.06525 or


6.525%

b. Standard deviations of returns on Stocks X and Y.

Variance Stock X = 0.25(-0.055-0.04775)+0.45(0.06-0.04775)+ 0.3(0.115-0.04775)


=000263939+000006750+000135677=000406366

Standard deviation Stock X= 000406366)^0.5 =006374684 or 6.37%

Variance Stock Y = 0.25(-0.105-0.06525)+0.45(0.08-0.06525)+ 0.3(0.185-0.06525)


=000724627+000009810+000430202 = 001164638

Standard deviation Stock Y= 001164638)^0.5 =01079184 or 10.79%


c. Which stock is riskier?

Stock Y is more risker as it has Standard deviation of 10.79% compare to stock X 6.37%.

d. Assume that 90% of your $100,000 portfolio is invested in Stock X, while the rest (or 10%) is
invested in Stock Y.

Expected return of your portfolio =( 0.9 *0.04775) +(0.1*0.06525) = 0.0495 or 4.95%

2.Using CAPM

E(R) = Rf+Beta (Rm- Rf)

= 4% +1.25 ( 12%-4%)

= 14%

Stock’s alpha if its actual return was 12.5% = 12.5% -14% = -1.5%

Stock X is undervalued since forcasted return is higher than actual return.

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