EF3320 HW1 October 27, 2023 Question 1 (Return and risk 5p) You have concluded that next year the return on a stock would have the following distribution Economic Status Probability Rate of Return Weak Economy O15 5% Static Economy 0.60 5% Strong Eeonomy 0.25 15% 1. What is your expected rate of return on the stock for the next year? What is the standard deviation of the stock? Question 2 (Portfolio 0.5pt) The table below shows the expected return on a stock A and a bond B. Stock A] Stock AL pe [Ss If.an investor would like a portfolio with an expected return of 10.2%, what are the portfolio weights of stock A and bond B ? Question (Portfolio 0.5pt) An investor has $10,000, She decides to have the following asset allocations: Block A] Treasury-Bill we | 120% 20%, How to interpret her portfolio weights? What is her investment in government bond and what is her investment in stock A? Question 4 (Portfolio variance Ipt) Recall from elass that the popilation variance and standard deviation of portfolio has the followingformulas. With two assets A and B: If the portfolio weight on asset A is w and the the portfolio weight on asset B w®, then PP swtet 4 we P = (w*)? Var(r) + (w®)? Varir®) + urtw® Cov(r4, r®) + wu" Cov(r4r®). With more than two assets: If the portfolio weight on asset iis w!, and asset i has return 7!, then x Payout cet 7?) = > (w*)? Var(r') + LV wheicov(e! r) a ra Suppose that au investor holds a portfolio of bonds X,Y and Z. Portfolio weights of the three assets are 20%, 50% anel 30%, respectively. ‘The table below shows the variance-covarianee matrix of the three assets. What is the standard deviation of the portfolio? z z Taam ¥ mean (Ce faass0 Tose Pama] Question 5 (AMR and GAR @.5pt) ‘The table below shows annual holding period retums on a stock over five years, What are the arithmetic and geometric means (AMR and GMR) of the stock's returns? Year_HPR 1 10% 2 19% 3 8% 4% 53% Question 6 (Margin trade Spt) Old Economy Traders opened an account to short sell 1,000 shares of Internet Dreams from the previous problem. After borrowing the shares of Internet Dreams, Old Economy Traders immedi- ately sells the shares in the market at $60. After the sale of the shares, Old Eeonomy Traders will not receive the dividend from the company. ‘The initial margin requirement was 50%. (The margin account pays no interest.) A year later, the price of Internet Dreams has fallen from $60 to $50, and the stock has paid a dividend of $2 per share in between. 1, What is the remaining margin in the account? (2pt) 22. If the maintenance margin requirement is 30%, will Old Eeonomy receive a margin call? (0.5pt) 3. What is the rate of return on the investinent? (0.5pt) Question 7 (Risk-free rate Ipt) Suppose that there are many stocks in the security market and that the characteristics of stocks A and. B are given as follows: tock Expected Return Standard Deviation a 10% Bm B 15% 10% Correlation Suppose that it is possible to borrow at the risk-free rate, ry. What must be the value of the riskfree rate so that there is no arbitrage? (Hint: Think about constructing a risk-free portfolio from stocks A and B.) Question 8 (Optimal complete portfolio Spt) A pension fund manager is considering three mutual funds. The fist is a stock fund, the second is a long-term government and corporate bond fund, and the third is. T-bill money market fund that yields a rate of 8%. The probability distribution of the risky Funds is as follows: Expected Return _ Standard Deviat Stock fund (S) 20% 0% Bond fund (B) 12% 15% The corcelation between the fund returns is 0.1 1. What are the investment proportions im the minimum-variance portfolio of the two tisky funds, and what is the expected value and standard deviation of its rate of return? (0.5pt) 2. Tabulate and draw the investment opportunity set of the two risky funds. Use investinent proportions for the stock fund of 0% to 100% in increments of 20%. ((.5pt) 3. Draw a tangent from the risk-free rate to the opportunity set. What is the expected return and standard deviation of the tangent portfolio? (Ipt) AL You have risk aversion coelficient of 4, so your utility is ‘What is the optimal complete portfolio that you will hold? Please give the portfolio weight on risk-froe asset and the risky assets. (Ipt)