Question

The management of Dandin Company is considering two choices for the best of investment portfolio that is either (1) a combination of financial assets A and B or (2) a combination of financial assets A and C. The planned investment is 50 per cent for each asset component in each portfolio.

The following are the estimated returns for all the three types of financial assets:

Table 1: Expected Return (%) of Financial Assets
Year A B C
2003 12 16 12
2004 14 14 14
2005 16 12 16

1)Calculate the expected return for each portfolio.
2)Calculate the standard deviation for each portfolio.
3)Choose the portfolio that Dandin Company should invest.

Answer 1

For the portfolio containing A and B the calculations are shown below :

Year	A	B	weight(W)	Return = W*A +W*B
2003	12	16	0.5	14
2004	14	14	0.5	14
2005	16	12	0.5	14
			Mean =	14

The expected return = 14%

Since the return is same for each year, The standard deviation is 0

For the portfolio containing A and C the calculations are shown below :

Year	A	C	weight(W)	Return = W*A +W*C	(Return - mean)	(Return - mean)^2
2003	12	12	0.5	12	-2	4
2004	14	14	0.5	14	0	0
2005	16	16	0.5	16	2	4
			Mean =	14		8
					Variance =	4
					Std deviation =	2

The expected return = 14%

The standard deviation is 0.02 or 2%

Hence the answers are:

1) The expected return for each portfolio is 14%

2)The std deviation of Portfolio A and B is 0

The std deviation of Portfolio A and C is 2%

3)the portfolio that Dandin Company should invest.is Portfolio A and B since the std deviation is 0, that isthe portfolio doesn't contain any risk.