Question

Consider the data contained in the table below, which lists 30 monthly excess returns to two different actively managed stock portfolios (A and B) and three different common risk factors (1, 2, and 3). (Note: You may find it useful to use a computer spreadsheet program such as Microsoft Excel to calculate your answers.)

Period		Portfolio A		Portfolio B		Factor 1		Factor 2		Factor 3
1		1.00	%	0.00	%	0.02	%	-0.99	%	-1.73	%
2		7.52		6.61		6.85		0.34		-1.18
3		5.12		5.91		4.71		-1.52		1.92
4		1.08		0.28		0.68		0.44		0.32
5		-1.99		-1.60		-2.89		-3.57		4.28
6		4.16		2.48		2.80		-3.40		-1.57
7		-0.80		-2.46		-2.69		-4.42		-1.89
8		-15.53		-15.42		-16.02		-5.96		5.62
9		6.14		4.12		5.85		0.02		-3.73
10		7.73		6.81		7.01		-3.38		-2.77
11		7.82		5.45		5.79		1.44		-3.78
12		9.62		4.94		5.84		-0.25		-4.91
13		5.24		2.73		3.39		1.25		-6.20
14		-3.10		-0.52		-4.20		-5.57		1.73
15		5.39		2.66		3.40		-3.87		-2.96
16		2.34		7.28		4.50		2.84		2.80
17		-2.82		0.13		-2.32		3.44		2.99
18		6.42		3.71		4.64		3.44		-4.36
19		-3.41		-0.60		-3.41		2.08		0.62
20		-1.18		-4.12		-1.38		-1.26		-1.28
21		-1.49		0.17		-2.72		3.16		-3.11
22		6.02		5.31		5.87		-6.43		-3.14
23		2.00		2.30		3.24		7.64		-8.01
24		7.25		6.99		7.78		7.06		-9.04
25		-4.89		-2.82		-4.47		4.08		-0.21
26		0.94		-2.00		2.54		21.45		-11.97
27		9.04		5.22		5.11		-16.77		7.81
28		-4.31		-3.06		-6.14		-7.59		8.65
29		-3.29		-0.56		-4.34		-5.78		5.32
30		3.78		1.80		4.59		13.23		-8.71

1. Compute the average monthly return and monthly standard return deviation for each portfolio and all three risk factors. Also state these values on an annualized basis. (Hint: Monthly returns can be annualized by multiplying them by 12, while monthly standard deviations can be annualized by multiplying them by the square root of 12.) Use a minus sign to enter negative values, if any. Do not round intermediate calculations. Round your answers to three decimal places.

   	Portfolio A	Portfolio B	Factor 1	Factor 2	Factor 3
   Monthly:
   Average	%	%	%	%	%
   Std Dev	%	%	%	%	%
   Annual:
   Average	%	%	%	%	%
   Std Dev	%	%	%	%	%

2. Based on the return and standard deviation calculations for the two portfolios from Part a, is it clear whether one portfolio outperformed the other over this time period? Do not make any additional calculations to answer this question.

   Portfolio A earned a -Select-higherlowerItem 21 return and a -Select-higherlowerItem 22 standard deviation than Portfolio B. Therefore, it -Select-isis notItem 23 clear that one portfolio outperformed the other over this time period.

3. Calculate the correlation coefficients between each pair of the common risk factors (i.e., 1 & 2, 1 & 3, and 2 & 3). Use a minus sign to enter negative values, if any. Do not round intermediate calculations. Round your answers to four decimal places.

   Correlation between 1 & 2:

   Correlation between 1 & 3:

   Correlation between 2 & 3:

4. In theory, what should be the value of the correlation coefficient between the common risk factors? Explain why.

   In theory the correlations should be -Select-equal to 0equal to 1equal to -1indefiniteItem 27 because we want the factors to be -Select-independent of each otherhighly correlatedItem 28 .

Answer 1

Question a. Average monthly return and monthly standard deviation for portfolio return

Answer:

	Portfolio A	Portfolio B	Factor 1	Factor 2	Factor 3
Monthly return
Average	0.794	0.377	0.015	-1.417	-2.027
Std Dev	5.576	4.720	5.325	6.506	4.834
Annual return
Average	9.526	4.527	0.182	-16.999	-24.323
Std Dev	19.293	16.332	18.426	22.511	16.727

Question b. Based on the return and standard deviation calculations for the two portfolios from Part a, is it clear whether one portfolio outperformed the other over this time period?

Answer: Portfolio A earned on average 0.794 monthly return and 5.576 standard deviation, both are higher than portfolio B. Therefore it is not clear that one portfolio outperformed the other over this time period

Question a. Correlation between each pair of the common risk factors

Answer:

Correlation between 1&2: 0.22.9

Correlation between 1&3: -5465

Correlation between 2&3: -7556

Question d: In theory, what should be the value of the correlation coefficient between the common risk factors?

answer:I n theory the correlations should be equal -1 for 1&2, because we want the factors to be  independent of each other. Highly correlated factors are 2&3.