Question

Question 2

You are a financial investor who actively buys and sells in the securities market. Now you have a portfolio, including four shares: $5,500 of Share A, $4,600 of Share B, $5,700 of Share C, and $2,500 of Share D

. Required: a) Compute the weights of the assets in your portfolio.

b) If your portfolio has provided you with returns of 5.7%, 10.5%, 8.7% and 13.2% over the past four years, respectively. Calculate the geometric average return of the portfolio for this period.

c) Assume that expected return of the stock A in your portfolio is 13.2%. The risk premium on the stocks of the same industry are 6.8%, betas of these stocks is 1.2. Calculate the risk-free rate of return using Capital market pricing model (CAPM).

d) You have another portfolio that comprises of two shares only: $500 blue chip shares and $700 junk shares.

Below is the data of your portfolio: Blue Chips Junk Expected return 13% 20% Standard Deviation of return 20% 45% Correlation of coefficient (p) 0.4 Compute the expected return of your portfolio.

e) Compute the expected risk (standard deviation) of the portfolio.

Answer 1

Solution:-

A. To Compute the weight of Assets in Portfolio-

Total Portfolio Value = Invested in Share A + Invested in Share B + Invested in Share C + Invested in Share D

Total Portfolio Value = $5,500 + $4,600 + $5,700 + $2,500

Total Portfolio Value = $18,300

Weight of Share A =

Weight of Share A =

Weight of Share A = 0.301

Weight of Share B =

Weight of Share B =

Weight of Share B = 0.251

Weight of Share C =

Weight of Share C =

Weight of Share C = 0.311

Weight of Share D =

Weight of Share D =

Weight of Share D = 0.137

B. To Calculate geometric average return of the portfolio-

Geometric average return =

Geometric average return =

Geometric average return = 9.49%

C. To Calculate Risk Free Rate-

Expected Return = Risk Free Rate + Beta * Risk Premium

0.132 = Risk Free Rate + 1.20 * 0.068

Risk Free Rate = 0.132 - 0.0816

Risk Free Rate = 5.04%

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