Question

In: Finance

Which is the optimal return combination for both the US/UK and US Spain? US UK SPAIN...

Which is the optimal return combination for both the US/UK and US Spain?

US UK SPAIN CH13 INTERNATIONAL PORTFOLIO DIVERSIFICATION ANALYSIS
ER 15% 12% 5% DEVELOPED VS EMERGING MARKET DIVERSIFICATION
STD 10% 9% 4% CAN-β= CAN$ rose by COL Peso fell by
CORR 1 0.33 0.06 COL-β= US&CAN* $Ret= US&COL* $Ret
CV 1.5 1.3333 1.25
Weights W1 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%
W2 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
US&UK ER 15.00% 14.70% 14.40% 14.10% 13.80% 13.50% 13.20% 12.90% 12.60% 12.30% 12.00%
STD 10.0% 9.34% 8.76% 8.29% 7.95% 7.75% 7.71% 7.82% 8.08% 8.48% 9.00%
US&SPAIN ER 15.00% 14.00% 13.00% 12.00% 11.00% 10.00% 9.00% 8.00% 7.00% 6.00% 5.00%
STD 10.00% 9.03% 8.09% 7.17% 6.30% 5.50% 4.79% 4.22% 3.87% 3.79% 4.00%

Solutions

Expert Solution

An optimal-risk portfolio is typically somewhere in the middle of the curve of returns and volatility, owing to the fact that the higher you go up the curve, the greater the proportion of risk you take on to the potential of return. On the other end, low risk/ low return portfolios have generally been considered a waste of time, as one can achieve a similar return by simply investing in risk-free securities and assets, like government bonds or sovereign treasuries.

An individual investor can determine how much volatility he or she is willing to maintain in his other portfolio by picking another point which lies along the so-called efficient frontier. An investor looks out for maximum returns for the amount of risk that he can handle.

In case the expected returns are given then we can compute the return per risk unit using Sharpe & Treynor Ratio and take a decision.

However, in the above scenario, US & UK at 40% & 60% as well as US & Spain at 10% and 90% should not be blindly taken to since it minimizes risk. We should consider the return per risk unit and take a decision.

For computing Return per risk unit we will divide the return in each scenario by the Standard Deviation

Weights W1 100% 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0%
W2 0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0% 90.0% 100.0%
US & UK ER 15.00% 14.70% 14.40% 14.10% 13.80% 13.50% 13.20% 12.90% 12.60% 12.30% 12.00%
STD 10.00% 9.34% 8.76% 8.29% 7.95% 7.75% 7.71% 7.82% 8.08% 8.48% 9.00%
           1.50            1.57            1.64            1.70            1.74            1.74            1.71            1.65            1.56            1.45            1.33
US & Spain ER 15.00% 14.00% 13.00% 12.00% 11.00% 10.00% 9.00% 8.00% 7.00% 6.00% 5.00%
STD 10.00% 9.03% 8.09% 7.17% 6.30% 5.50% 4.79% 4.22% 3.87% 3.79% 4.00%
           1.50            1.55            1.61            1.67            1.75            1.82            1.88            1.90            1.81            1.58            1.25

Hence, We should choose 50% - 50% distribution for US & UK and 30% - 70% for US & Spain portfolio, since it maximises return per risk unit.


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