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Risk & Return Practice Questions

Risk and return portfolio

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MUHAMMAD SHAFI
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47 views2 pages

Risk & Return Practice Questions

Risk and return portfolio

Uploaded by

MUHAMMAD SHAFI
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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PORTFOLIO MANAGEMENT

1. Considering the world economic outlook for the coming year and estimates of sales and earnings for the
pharmaceutical industry, you expect the rate of return for Lauren Labs common stock to range between −20 percent
and +40 percent with the following probabilities.
Probability Possible Returns
0.10 −0.20
0.15 −0.05
0.20 0.10
0.25 0.15
0.20 0.20
0.10 0.40
Compute the expected rate of return E(Ri) for Lauren Labs.

2. Given the following market values of stocks in your portfolio and their expected rates of return, what is the
expected rate of return for your common stock portfolio?
Stock Market Value ($ Mil.) E(Ri )
Disney $15,000 0.14
Starbucks 17,000 −0.04
Harley Davidson 32,000 0.18
Intel 23,000 0.16
Walgreens 7,000 0.12

3. The following are the monthly rates of return for Madison Cookies and for Sophie Electric during a six-month
period.
Month Madison Cookies Sophie Electric
1 −0.04 0.07
2 0.06 −0.02
3 −0.07 −0.10
4 0.12 0.15
5 −0.02 −0.06
6 0.05 0.02
Compute the following.
a. Average monthly rate of return Ri for each stock
b. Standard deviation of returns for each stock
c. Covariance between the rates of return
d. The correlation coefficient between the rates of return
What level of correlation did you expect? How did your expectations compare with the computed correlation?
Would these two stocks be good choices for diversification? Why or why not?

4. You are considering two assets with the following characteristics.

E(R1) = 0:15 E(σ1) = 0:10 w1 = 0:5


E(R2)) = 0:20 E(σ2) = 0:20 w2 = 0:5
Compute the mean and standard deviation of two portfolios if r1,2 = 0.40 and −0.60, respectively. Plot the two
portfolios on a risk–return graph and briefly explain the results.

5. Given:
E(R1) = 0:10
E(R2) = 0:15
E(σ1) = 0:03
E(σ2) = 0:05
Calculate the expected returns and expected standard deviations of a two-stock portfolio in which Stock 1 has a
weight of 60 percent under the following conditions.
a. r1,2 = 1.00
b. r1,2 = 0.75
c. r1,2 = 0.25
d. r1,2 = 0.00
e. r1,2 = −0.25
f. r1,2 = −0.75
g. r1,2 = −1.00

6. Given:
E(R1) = 0:12
E(R2) = 0:16
E(σ1) = 0:04
E(σ2) = 0:06
Calculate the expected returns and expected standard deviations of a two-stock portfolio having a correlation
coefficient of 0.70 under the following conditions.
a. w1 = 1.00
b. w1 = 0.75
c. w1 = 0.50
d. w1 = 0.25
e. w1 = 0.05
Plot the results on a return-risk graph. Without calculations, draw in what the curve would look like first if the
correlation coefficient had been 0.00 and then if it had been −0.70.

7. The following are monthly percentage price changes for four market indexes.
Month DJIA S&P 500 Russell 2000 Nikkei
1 0.03 0.02 0.04 0.04
2 0.07 0.06 0.10 −0.02
3 −0.02 −0.01 −0.04 0.07
4 0.01 0.03 0.03 0.02
5 0.05 0.04 0.11 0.02
6 −0.06 −0.04 −0.08 0.06
Compute the following.
a. Average monthly rate of return for each index
b. Standard deviation for each index
c. Covariance between the rates of return for the following indexes:
DJIA–S&P 500
S&P 500–Russell 2000
S&P 500–Nikkei
Russell 2000–Nikkei
d. The correlation coefficients for the same four combinations
e. Using the answers from parts (a), (b), and (d), calculate the expected return and standarddeviation of a portfolio
consisting of equal parts of (1) the S&P and the Russell 2000 and (2) the S&P and the Nikkei. Discuss the two
portfolios.

8. The standard deviation of Shamrock Corp. stock is 19 percent. The standard deviation of Cara Co. stock is 14
percent. The covariance between these two stocks is 100. What is the correlation between Shamrock and Cara stock?

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