Question

In: Finance

Someone holds X stock (ABCD.JK). To minimize the risk, he wants to add another stock, He...

Someone holds X stock (ABCD.JK). To minimize the risk, he wants to add another stock, He is considering to add Y (EFGH.JK) or Z (PQRS.JK). He gathers some information to help him make a decision:

	EFGH.JK	PQRS.JK
Beta	1.25	0.79
Standard Deviation	0.16	0.28
Correlation with ABCD.JK	0.555	0.155
Return	5.1%	18%

The standard deviation of ABCD.JK is 0.1 and the return of ABCD.JK is 4%. The investor wants to build an equality weighted portfolio (both 50% weight). To help him decide, please calculate:

a. The portfolio’s expected return of ABCD.JK and EFGH.JK

b. The portfolio’s expected return between ABCD.JK and PQRS.JK

c. The portfolio’s standard deviation between ABCD.JK and EFGH.JK

D. The portfolio’s standard deviation between ABCD.JK and PQRS.JK

e. Which stock should he add? DEFG.JK or PQRS.JK? Explain!

Expert Solution

	Expected return	Investment Proportion	Standard Deviation	Correlation with ABCD.JK
ABCD.JK	4.00%	50%	0.10
EFGH.JK	5.10%	50%	0.16	0.555
Total		100%
Expected return of portfolio	4.55%
Standard deviation of portfolio	0.1155
return per unit of risk	0.3939

	Expected return	Investment Proportion	Standard Deviation	Correlation with ABCD.JK
ABCD.JK	4.00%	50%	0.10
PQRS.JK	18.00%	50%	0.28	0.155
Total		100%
Expected return of portfolio	11.00%
Standard deviation of portfolio	0.1558
return per unit of risk	0.7061

The portfolio’s expected return of ABCD.JK and EFGH.JK

4.55%

The portfolio’s expected return between ABCD.JK and PQRS.JK

11.00%

c. The portfolio’s standard deviation between ABCD.JK and EFGH.JK

0.1155

D. The portfolio’s standard deviation between ABCD.JK and PQRS.JK

0.1558

e. Which stock should he add? EFGH.JK or PQRS.JK? Explain!

Stock should be added is PQRS.JK because portfolio with this stock has higher return and return per unit of risk is lower for this combination.

Formulas used in excel:

jeff jeffy answered 3 months ago

Campbell's father holds just one stock, G Co., which he thinks is a very low risk...

Campbell's father holds just one stock, G Co., which he thinks is a very low risk security. Campbell agrees that the stock is relatively safe, but he wants to demonstrate to his father that he could still reduce his risk by diversifying. He obtained the return shown below on G and E Corp. Both have had less variability than most other stocks over the past 5 years. Year G E Portfolio: 50% G and 50% E 2015 0.40 0.40 2016...

A French citizen holds a piece of land in the city of London that he wants...

A French citizen holds a piece of land in the city of London that he wants to sell in one year. If the British economy booms in the future, the land will be worth £2,000 and one British pound will be worth of €2.5. If the British economy slows down, the land will be worth of £1,500, and the pound will be worth of €2. He estimates that the British economy will experience a boom with a 60% probability and...

Company X is planning to add another project, which will generate $125,000 annual revenue for the...

Company X is planning to add another project, which will generate $125,000 annual revenue for the company in the next 6 years, with operating costs of $50,500 per year. To take this new project, the company has to purchase a new equipment with a price of $168,000 and add additional $40,000 in net working capital. The equipment will be depreciated using 7-year MACRS depreciation method (7-year MACRS depreciation rates are showing below). The company thinks the equipment could be sold...

When someone owns an asset (such as a share of stock) that rises in value, he...

When someone owns an asset (such as a share of stock) that rises in value, he has an “accrued” capital gain. If he sells the asset, he “realizes” the gains that have previously accrued. Under the U.S. income tax, realized capital gains are taxed, but accrued gains are not. The higher the tax on capital gains, the ---------------------------- likely the investor would sell the investment. Cuts in capital gains tax rates can raise tax revenue if the lower tax rate...

John holds 100 shares of stock with a total basis of $1000. He receives a 25%...

John holds 100 shares of stock with a total basis of $1000. He receives a 25% stock dividend at the end of year 1. In year two, he sales 30 of his shares when the stock price is $15.00 per share. Please calculate his gain in year two.

Allen wants to open a savings account. He will transfer $40,000 from another account to the...

Allen wants to open a savings account. He will transfer $40,000 from another account to the savings account today. After that, he will deposit $1,000 every month to the savings account. If the annual interest rate is 3.2%, what will be the account balance in his savings account after 5 years? a. $112,653.52 b. $123,877.44 c. $123,877.23 d. $111,903.31 how would this be solved using finance functions in excel?

Why might someone want to know his or he risk of developing a serious disease if...

Why might someone want to know his or he risk of developing a serious disease if little can be done to prevent it? Would you want to know your own risk? Why or why not?

Larry Nelson holds 1,000 shares of General Electric common stock. As a shareholder, he has the...

Larry Nelson holds 1,000 shares of General Electric common stock. As a shareholder, he has the right to be involved in the election of its directors. These directors are responsible for managing the company and achieving the company’s objectives. True or False: Larry can invest in another company that is selling class A shares to the public, and class B shares will be retained by company insiders. This will help the founders maintain control in the company. True False Larry...

Myles Houck holds 500 shares of Lubbock Gas and Light. He bought the stock several years...

Myles Houck holds 500 shares of Lubbock Gas and Light. He bought the stock several years ago at $ 47.91 and the shares are now trading at $ 75.50 Myles is concerned that the market is beginning to soften. He doesn't want to sell the stock, but he would like to be able to protect the profit he's made. He decides to hedge his position by buying 5 puts on Lubbock G&L. The 3-month puts carry a strike price of...

Larry Nelson holds 1,000 shares of General Electric (GE) common stock. As a stockholder, he has...

Larry Nelson holds 1,000 shares of General Electric (GE) common stock. As a stockholder, he has the right to be involved in the election of its directors, who are responsible for managing the company and achieving the company’s objectives. True or False: Larry can vote in person at the company’s annual meeting, through the mail, or by transferring the right to vote to another person by means of proxy. Larry also holds 2,000 shares of common stock in a company...