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

				price	price	R1	R2	D1=R1-0.013883	D2=R2-(-0.02589)	D1^2	D2^2
			Year	ASX: WBC	SGX: C6L	ASX: WBC(Return)	SGX: C6L(Return)	Deviation of Return From Mean(WBC)	Deviation of Return From Mean(C6L)	Deviation Squared(WBC)	Deviation Squared(C6L)
			2009	23.7	13.82
			2010	22.85	14.76	-0.03586	0.068017	-0.049747979	0.093907366	0.002474861	0.008818593
			2011	21.01	11.1	-0.08053	-0.24797	-0.094408164	-0.22207748	0.008912901	0.049318407
			2012	27.85	10.99	0.325559	-0.00991	0.311676257	0.01598009	0.097142089	0.000255363
			2013	30.66	9.59	0.100898	-0.12739	0.087014666	-0.101498535	0.007571552	0.010301953
			2014	34.23	12.65	0.116438	0.319082	0.102555356	0.344972377	0.010517601	0.119005941
			2015	30.85	11.03	-0.09874	-0.12806	-0.112626792	-0.102173241	0.012684794	0.010439371
			2016	31.71	9.9	0.027877	-0.10245	0.013993823	-0.076557869	0.000195827	0.005861107
			2017	30.96	11.31	-0.02365	0.142424	-0.037534845	0.168314242	0.001408865	0.028329684
			2018	24.55	9.65	-0.20704	-0.14677	-0.220924344	-0.120882767	0.048807566	0.014612643
					SUM	0.124945	-0.23303		SUM	0.189716057	0.246943064
		Return of WBC in 2010=(22.85/23.7)-1	-0.035864979
		Return of C6L in 2010=(14.76/13.82)-1	0.068017366
		Return of stock in Year (N+1)=((Price in Year (N+1)/(Price in Year (N)))-1
		Average (Mean )Return of WBC=SUM/9=	0.013882776	(0.124945/9)
		Average (Mean )Return of C6L=SUM/9=	-0.025891757	(-0.23303/9)
		Variance of return =SUMof Deviationsquared/(9-1)
		Variance of Return of WBC	0.023714507	(0.189716057/8)
		Variance of Return of CL6	0.030867883	(0.246943064/8)
		Standard Deviation =Square Root of Variance
		Standard Deviation of Return of WBC	0.153995153	(SQRT(0.023715)
		Standard Deviation of Return of CL6	0.175692581	(SQRT(0.030868)
		Expected (average) return of WBC is higher
		Standard Deviation of WBC is lower
		Hence ASX:WBC will be preferred
		Since CL6 has expected negative return, all investors will prefer to invest in WBC