There are two stocks, A and B. In Fin6301, we have discussed the concept of a...

There are two stocks, A and B. In Fin6301, we have discussed the concept of a portfolio, which is just a basket of several stocks. Under any circumstance, if you invest 40% of your money in Stock A and the rest (60%) in Stock B, the portfolio return Rp = 40%*RA+60%*RB. Suppose the possible returns next year and the corresponding probabilities are given as follows,

Possible State of Economy	Probability	RA	RB	Rp1	Rp2
Recession	.25	-5%	10%
Normal	.4	10%	15%
Growth	.35	15%	5%

Your financial advisor recommended two portfolios constructed using both stocks with portfolio P1 investing 20% in Stock A, while portfolio P2 investing 60% in Stock A.

(a) What are the returns of each portfolio in each state of the economy?

(b) What are the expected returns for stocks A and B, and portfolios P1 and P2, i.e., E(RA), E(RB),

E(Rp1), and E(Rp2)?

consider their volatilities)

(d) Comparing Stock B with portfolio P1, does reduction in volatility justify loss in expected return

when holding the portfolio?

Solutions

Expert Solution

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

Cell reference -

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

jeff jeffy answered 1 month ago

Next > < Previous

Related Solutions

In this week's lecture we have discussed the concept of insider trading as it exists and...

In this week's lecture we have discussed the concept of insider trading as it exists and is viewed around the world. Discuss your view on how insider trading should be viewed

One of the key concepts we have discussed this semester is the concept of “Elasticity”. Generally...

One of the key concepts we have discussed this semester is the concept of “Elasticity”. Generally speaking, elasticity is simply a measure of how responsive one variable is to a change in another variable. While we have focused on the “own price elasticity of demand”, the “income elasticity of demand” and the “cross-price elasticity of demand” this concept can be extended to a number of different situations. (10 pts) The demand curve for a product is given by Qx=1,000-2Px+0.02Pz, where Pz...

Name two different chemicals we have discussed or read about that we have added to the...

Name two different chemicals we have discussed or read about that we have added to the carbon cycle at levels that did not exist naturally. a. Which functional group class does each chemical belong to? Explain. b. How do the respective types of bonding and functional group classes of these molecules affect their reactivity? c. What are the health and environmental effects of the two chemicals you choose to report on? Make sure to obtain your information from reliable sources...

We have discussed stocks, capital budgeting and M&As. Discuss how the efficient market hypothesis can be...

We have discussed stocks, capital budgeting and M&As. Discuss how the efficient market hypothesis can be used to explain the results we see in each area.

Assume that we have 3 Stocks A, B & C. A B C Expected return 8%...

Assume that we have 3 Stocks A, B & C. A B C Expected return 8% 12% 6% Variance 0.012 0.028 0.009 If the covariance between stock A & B return is equal to 0.009159, stock A & C return is equal to -0.005146 and stock B & C return 0.01572 Required Calculate the Standard Deviation for stock A, B & C. which stock is risky and why? Calculate the correlation between every two stocks. What is the indication of...

We have the following information on Stocks A and B. The risk-free rate is 5%, and...

We have the following information on Stocks A and B. The risk-free rate is 5%, and the market risk premium is 6.25%. Assume that the market portfolio is correctly priced. Based on the reward-to-risk ratio, are Stocks A and B overpriced, underpriced, or correctly priced? Stock A Stock B Expected return 10% 15% Beta 0.8 1.5 Select one: a. A is underpriced; B is overpriced. b. A is correctly priced; B is overpriced. c. A is overpriced; B is underpriced....

Recall that we discussed the concept of the Global Minimum Variance Portfolio in one of the...

Recall that we discussed the concept of the Global Minimum Variance Portfolio in one of the lectures and defined it as that portfolio on the efficient frontier that has the least risk. Now, consider a portfolio with only two assets, asset X, and asset Y. The returns of these assets are uncorrelated with each other. Asset X has a volatility of 9%, and asset Y’s volatility is 16%. What will be the weight of asset X in a minimum variance...

Suppose we had two stocks, A and B. Both are selling for $10 in the market....

Suppose we had two stocks, A and B. Both are selling for $10 in the market. Stock A has an expected rate of return of 2%, while stock B has an expected rate of return for 6%. (a)What is the expected income one would receive from holding Stock A? How about for Stock B? (b)Given that their market prices are equal, which stock do you think incurs a greater amount of risk? Why? Suppose the market changes, such that now...

B. Compare and contrast these two case studies: The first one we discussed in class, General...

B. Compare and contrast these two case studies: The first one we discussed in class, General Motors (GM), which decided to offshore production from the USA to Mexico. When GM began this in the late 70s, it was a relatively new idea for a major American producer, and was highly controversial, but the trend has grown over the decades, and nowadays other major car companies, including European and Asian giants like BMW and Honda, have followed the same strategy to...

B. Compare and contrast these two case studies: (350 words) The first one we discussed in...

B. Compare and contrast these two case studies: (350 words) The first one we discussed in class, General Motors (GM), which decided to offshore production from the USA to Mexico. When GM began this in the late 70s, it was a relatively new idea for a major American producer, and was highly controversial, but the trend has grown over the decades, and nowadays other major car companies, including European and Asian giants like BMW and Honda, have followed the same...

Subjects