Question

Part 2

Risk and return You are considering an investment in the stock market and have identified two potential stocks, they are Westpac Banking Corp. (ASX: WBC) and Singapore Airlines Ltd. (SGX: C6L). The historical prices for the past 10 years are shown in the table below

Year	ASX: WBC	SGX: C6L
2009	23.70	13.82
2010	22.85	14.76
2011	21.01	11.1
2012	27.85	10.99
2013	30.66	9.59
2014	34.23	12.65
2015	30.85	11.03
2016	31.71	9.9
2017	30.96	11.31
2018	24.55	9.65

1. Which stocks would you prefer to own? Would everyone make the same choice? Explain your answer(s).

2. Calculate the correlation coefficient between the two stocks. Does it appear that a portfolio consisting of WBC and C6L would provide good diversification? Explain your answer(s).

3. Calculate the expected (annual) return if you owned a portfolio consisting of 50% in WBC and 50% in C6L. Would you prefer the portfolio to owning either of the stocks alone?

Answer 1

1) WBC provides a return of 1.39% from 2009 to 2018 and the return C6L is - 2.59%. Since WBC provides positive returns for a 10 year period, it is the preferred investment. For investment period of 10 years, everyone wold prefer WBC. But if the investment horizon is short one i.e. one year or less, then C6L may also be considered as C6L has provided positive returns for 1 year periods and the standard deviation is lesser for C6L compared to WBC stock.

2) Correlation coefficient between two stocks is - 0.32842. A portfolio consisting of WBC and C6L would provide a good diversification as the correlation coefficient is negative. Negative correlation coefficient means that prices of stocks would move in opposite directions and overall the portfolio returns would be less volatile.

3) Annual return of WBC = 1.39%

Annual return of C6L = - 2.59 %

Expected return = 0.5 * 1.39 % + 0.5 * (- 2.59%) = - 0.6 %