Question

Mr. Thomas has just inherited $ 1000,000. He could either invest his money in the bank which gives a return of 4% or invest in shares of Monopoly Corp which is the only company in the market. Shares of Monopoly Corp offer an average return of 12% and a risk of 10%.

a) If Mr. Thomas wants a return of 10%, how much money does he need to invest in shares ?

b) Calculate the risk of his investment strategy.

Answer 1

Investment Amount = $1,000,000

Bank's rate of return = 4%

Bank's risk = 0%

Monopoly Corp's average return = 12%

Monopoly Corp's risk = 10%

a) Mr. Thomas wants a return of 10%

He has to invest some portion say (Wb) in Bank and some portion say (Ws) in Monopoly shares to generate 10% rate of return. we can express this with following equation.

where,

Rp = Mr. Thomas's Portfolio return i.e 10%

Rb = bank return i.e 4%

Rs = Share return i.e 12%

Wb = Amount invested in Bank

Ws = Amount invested in Share

Wb = (1-Ws)

putting values and solve for Ws -

Thus, Amount in Invested in Monopoly share is 75% of 1,000,000 = $750,000

Remaining balance i.e 25% of 1,000,000 is invested in Bank = $250,000

b)

We can calculate the risk of investment strategy with following equation -

where,

risk of investment strategy

risk of monopoly share i.e 10%

risk of bank i.e 0%

Putting the values

Thus, risk of investment strategy is 7.5%

Hope this will help, please do comment if you need any further explanation. Your feedback would be appreciated.