Question

Based on current dividend yields and expected capital gains, the expected return on portfolios A and B are 11% and 14% respectively. The beta of A is 0.8 while that of B is 1.5. The rate of exchange fund bill is currently 6%, while the expected return of the Hang Seng Index is 12%. The standard deviation of portfolio A is 10%, while that of B is 31%, and that of the index is 20%.

a. If you currently hold the Hang Seng Index, would you choose to add portfolio A or B to your holdings?

b. If you currently hold the exchange fund bills, which one would you choose (i.e. portfolio A, portfolio B or the Hang Seng Index) to add to your holdings?

c. What would happen if we measure the performance of a poorly diversified portfolio using Treynor measure? (6marks)

Answer 1

Solution:-

a)          From the above two portfolio I will select portfolio A to hold .The reason for the above is portfolio B have high expected return,beta is greater than 1 and high standard deviation. But,Due to the standard deviation of portfolio B is very high, High standard deviation on portfolio investment is risky for hold.Portfolio A having return is very low ,beta is less than 1 ,however the portfolio A will be more suitable to hold for long period.

             Here,the portfolio A will get 11% of expected return while portfolio will get return at 14%.Beta for portfolio B is greater than 1.Beta is a measure of stock’s velocity in relation to the overall market.Beta is calculated using regression analysis.A beta of 1 indicated that the securities price tend to move with the market.A beta greater than 1 indicates that the security price tends to move volatile than the market.A beta less than 1 indicates it tends to be less volatile than the market. From the above two we can see that the standard deviation of portfolio B is very high compared with Portfolio A.

           The standard deviation will determine the portfolio performance ,it will helps to determine the market volatility or the spread of asset prices from their average price. When prices move wildly ,standard deviation is high ,investment with high standard deviation is risky .Low standard Deviation means prices are calm ,so investment come with low risk.

            So that i will hold portfolio A .