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Tutorial 4

This document provides information and questions about investment portfolio management. It gives the expected returns, standard deviations, and correlation for three mutual funds: a stock fund, bond fund, and T-bill money market fund. It asks questions about constructing efficient portfolios from these funds, including calculating minimum variance portfolios, plotting the opportunity set, finding the optimal portfolio, and determining investment proportions to achieve a target return. It also provides correlation data for four stocks and asks which stock should be added to optimize a portfolio containing one of the stocks.

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Huế Hoàng
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17 views

Tutorial 4

This document provides information and questions about investment portfolio management. It gives the expected returns, standard deviations, and correlation for three mutual funds: a stock fund, bond fund, and T-bill money market fund. It asks questions about constructing efficient portfolios from these funds, including calculating minimum variance portfolios, plotting the opportunity set, finding the optimal portfolio, and determining investment proportions to achieve a target return. It also provides correlation data for four stocks and asks which stock should be added to optimize a portfolio containing one of the stocks.

Uploaded by

Huế Hoàng
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Investment and Portfolio Management

TOPIC 4 – TUTORIAL 4

The following data apply to Problems 1 through 7:

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is
a long-term government and corporate bond fund, and the third is a T-bill money market fund that
yields a rate of 8%. The probability distribution of the risky funds is as follows:

Expected Return (%) Standard deviation (%)


Stock Fund (S) 20 30
Bond Fund (B) 12 15

The correlation between the fund returns is 0.2

1. What are the investment proportions in the minimum-variance portfolio of the two risky
funds, and what is the expected value and standard deviation of its rate of return?

2. Tabulate and draw the investment opportunity set of the two risky funds. Use investment
proportions for the stock fund of 0% to 100% in increments of 20%.

3. Draw a tangent from the risk-free rate to the opportunity set. What does your graph show for
the expected return and standard deviation of the optimal portfolio?

4. Solve numerically for the proportions of each asset and for the expected return and standard
deviation of the optimal risky portfolio.

5. What is the Sharpe ratio of the best feasible CAL?

6. You require that your portfolio yield an expected return of 14%, and that it be efficient, on
the best feasible CAL.
a. What is the standard deviation of your portfolio?
b. What is the proportion invested in the T-bill fund and each of the two risky funds?

7. If you were to use only the two risky funds, and still require an expected return of 14%, what
would be the investment proportions of your portfolio? Compare its standard deviation to that
of the optimized portfolio in Problem 6.
What do you conclude?
Investment and Portfolio Management

The following data are for Problems 8 through 10: The correlation coefficients between several
pairs of stocks are as follows: Corr(A, B) = 0.85; Corr(A, C) = - 0.60; Corr(A, D) = 0.45. Each
stock has an expected return of 9% and a standard deviation of 20%.

8. If your entire portfolio is now composed of stock A and you can add some of only one stock
to your portfolio, would you choose (explain your choice):
a. B
b. C
c. D
d. Need more data

9. Would the answer to Problem 8 change for more risk-averse or risk-tolerant investors?
Explain.

10. Suppose that in addition to investing in one more stock you can invest in T-bills as well.
Would you change your answers to Problems 8 and 9 if the T-bill rate is 9%?

Extra exercises:

1. True or false: Assume that expected returns and standard deviations for all securities (including
the risk-free rate for borrowing and lending) are known. In this case, all investors will have the
same optimal risky portfolio.

Assume that expected returns and standard deviations for all securities (including the risk-free
rate for borrowing and lending) are known. In this case, all investors will have the same
optimal complete portfolio.

2. True or false: The standard deviation of the portfolio is always equal to the weighted average
of the standard deviations of the assets in the portfolio.

3. Statistics for three stocks, A, B, and C, are shown in the following tables.
Investment and Portfolio Management

Using only the information provided in the tables, and given a choice between a portfolio made up
of equal amounts of stocks A and B or a portfolio made up of equal amounts of stocks B and C,
which portfolio would you recommend? Justify your choice.

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