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    Tutorial 3 Questions

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    This document contains sample questions and answers about key concepts in portfolio management including correlation between stocks, efficient portfolios, expected returns and standard deviations of portfolios, and the impact of correlation on risk. It provides an example of calculating the expected return and standard deviation of a three stock portfolio given the expected returns, standard deviations, allocations, and correlations between each stock.

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    Tutorial 3 Questions

    Uploaded by

    hrfjbjrfrf
    16 views2 pages
    This document contains sample questions and answers about key concepts in portfolio management including correlation between stocks, efficient portfolios, expected returns and standard deviations of portfolios, and the impact of correlation on risk. It provides an example of calculating the expected return and standard deviation of a three stock portfolio given the expected returns, standard deviations, allocations, and correlations between each stock.

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    This document contains sample questions and answers about key concepts in portfolio management including correlation between stocks, efficient portfolios, expected returns and standard deviations of portfolios, and the impact of correlation on risk. It provides an example of calculating the expected return and standard deviation of a three stock portfolio given the expected returns, standard deviations, allocations, and correlations between each stock.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    16 views2 pages

    Tutorial 3 Questions

    Uploaded by

    hrfjbjrfrf
    This document contains sample questions and answers about key concepts in portfolio management including correlation between stocks, efficient portfolios, expected returns and standard deviations of portfolios, and the impact of correlation on risk. It provides an example of calculating the expected return and standard deviation of a three stock portfolio given the expected returns, standard deviations, allocations, and correlations between each stock.

    Copyright:

    © All Rights Reserved
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    of 2

    Tutorial 3

    Concept questions
    1. If the returns on two stocks are highly correlated, what does this mean? If they
    have no correlation? If they are negatively correlated?

    If the returns on two stocks are highly correlated, they have a strong tendency to
    move up and down together. (Less diversification is attained)

    If they have no correlation, there is no particular connection between the two.


    (Benefit from diversification)

    If they are negatively correlated, they tend to move in opposite directions. (Get a
    good diversification benefit)

    2. What is an efficient portfolio?

    A portfolio that provides the greatest expected return for a given level of risk (i.e.,
    standard deviation), or, equivalently, the lowest risk for a given expected return.

    An efficient portfolio refers to a portfolio that offers the highest possible expected
    return for a given risk or the lowest possible risk for a given level of expected
    return

    In other words, it represents a portfolio that provides the best trade-off between
    risk and return

    -maximize the return of the investors


    -minimize the risk of the investors

    3. True or false: If two stocks have the same expected return of 12 percent, then
    any portfolio of the two stocks will also have an expected return of 12 percent.

    True, the expected return is simply the weighted average return of the individual
    assets.

    Expected return = WARA + WBRB


    = 0.5(0.12) + 0.5(0.12)
    = 0.7(0.12) + 0.3 (0.12)

    4. True or false: If two stocks have the same standard deviation of 45 percent, then
    any portfolio of the two stocks will also have a standard deviation of 45 percent.

    False. the principle of diversification-correlation matters. This statement is only


    true if the correlation between the two stocks is exactly 1.
    5. Assume you are a very risk adverse investor, why might you still be willing to add
    an investment with high volatility into your portfolio?

    An investment with high volatility could actually reduce the risk of the overall
    portfolio if its correlation to the existing assets is very low or negative.

    Problem Solving Questions


    6. You have a three-stock portfolio. Stock A has an expected return of 12 percent
    and a standard deviation of 41 percent, Stock B has an expected return of 16
    percent and a standard deviation of 58 percent, and Stock C has an expected return
    of 13 percent and a standard deviation of 48 percent. The correlation between
    Stocks A and B is .30, between Stocks A and C is .20, and between Stocks B and C
    is .05. Your portfolio consists of 45 percent Stock A, 25 percent Stock B, and 30
    percent Stock C.
    Required: Calculate the expected return and standard deviation of your portfolio.

    Expected return
    E(Rp) = 0.45(0.12) + 0.25(0.16) + 0.30(0.13)
    = 0.054 + 0.04 + 0.039
    = 0.133

    Standard deviation – risk of portfolio


    σp^2= 0.45^2 (0.41^2) + 0.25^2 (0.58^2) + 0.30^2 (0.48^2) + 2 (0.45) (0.25) (0.30) (0.41)
    (0.58) (0.48)

    Additional Question for student self-attempt


    7. Calculate the expected return and standard deviation of a carefully constructed
    three-stock portfolio? The portfolio's allocation comprises 30% invested in Stock A,
    30% invested in Stock B, and 40% invested in Stock C. Stock A presents an
    expected return of 15% with a standard deviation of 20%. Stock B boasts an
    expected return of 20% and a standard deviation of 24%. Additionally, Stock C
    exhibits an expected return of 35% alongside a standard deviation of 48%.
    Furthermore, to navigate the intricacies of interdependence, the investor found that
    the correlation between Stock A and Stock B is 0.2, between Stock A and Stock C is
    0.4, and between Stock B and Stock C is -0.3.

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