RISK AND PERFORMANCE LABORATORY

8.2 What is the expected return on the following investment?

Probability Performance Expected

performance

0 30 9
0 10 2
1 -2 -1
1 10.00

The expected return is 10%

8.3 Susan's investment portfolio contains three stocks that have a total value of $100,000. The beta
for this portfolio is 15. Susan considers investing an additional $60,000 in a stock that has a beta
of 8. After adding this action. What would be the new beta of the portfolio?

Investment wj beta action Beta Portfolio

1 33,333 0.21 1.5 0.31
2 33,333 0.21 1.5 0.31
3 33,333 0.21 1.5 0.31
4 60,000 0.38 3 1.13
TOTAL 160000 1 2.06

The new beta for the portfolio is 2.06

8.4 Suppose Rlr = 5%, rM = 12%. What is the appropriate required rate of return for a stock with a beta
of 1.5?

rLR= 5%
rM= 12%
Bx= 1.5
rp= 0.155 15.50%

The required rate of return on the stock is 15.50%

8.8
Currently the risk-free return is 3 percent and the expected market rate of return is 10 percent.
What is the expected return on the following portfolio of three stocks?

rLR= 3%
rM= 10
rp= x %
 Amount invested Beta W.B.
400000 0.4 1.5 0.6
500000 0.5 2 1
100000 0.1 4 0.4
Total= 1000000 Beta = 2

rp= rLR+(rM-rLR)B 17.00%

The expected return is 17%

8.9 The market and the stock S have the following probability distribution

Probability rM rs
0.30 15 20
0.40 9 5
0.30 18 12

a) Calculate the expected rate of return for the market and the stock S

Probability Performance Expected Probability Performance Expected

performance performance

0.3 15 4.5 0.3 20 6

0.4 9 3.6 0.4 5 2
0.3 18 5.4 0.3 12 3.6
1.0 13.50 1.0 11.60
The expected rate of return for the market is 13.50
The expected rate of return for the stock is 11.60

b) Calculate the standard deviation of the market and the stock S

Market standard deviation

PerformanceR - expected Subtotal r^2 Probability Total
15.0 13.5 1.5 2.3 0.3 0.7
9.0 13.5 - 4.5 20.3 0.4 8.1
18 13.5 4.5 20.3 0.3 6.1
Variance 14.9
Standard deviation 3.85
Standard deviation of the S stock
Return R - expected Sub - total r^2 Probability Total
20.0 11.6 8.4 70.6 0.3 21.2
5.0 11.6 - 6.6 43.6 0.4 17.4
12.0 11.6 0.4 0.2 0.3 0.0
The expected return is 10%...................................................................................................................10
The new beta for the portfolio is 2.06...................................................................................................10
The required rate of return on the stock is 15.50%...............................................................................10
The expected return is 17%.....................................................................................................................2
The expected rate of return for the market is 13.50................................................................................2
The expected rate of return for the stock is 11.60...................................................................................2
Standard deviation of the S stock............................................................................................................2
Standard deviation of the action Y..........................................................................................................5
Its new beta would be 1.1.......................................................................................................................5
The expected return is 15.50%................................................................................................................5
16.5%....................................................................................................................................................14
The expected return is 16.5%................................................................................................................14
If the market rate increases, the expected return increases, if the market rate decreases the return also
decreases...............................................................................................................................................14
The beta is 0.7625...................................................................................................................................6
The expected return of the fund is 12.10%.............................................................................................6
The expected return for investment C is 8..............................................................................................6
The standard deviation is 6.63................................................................................................................7
I would prefer to buy option C, since it has less risk in the purchase.....................................................7
The average rate of return for Stock A is 11.5 and the average rate of return for Stock B is 11.3.........8
The average rate of return for Stock A is 5.75 and the average rate of return for Stock B is 5.65. What
would have been the average return on the portfolio during this period?..............................................8
The average return on the portfolio would be: 5.7..................................................................................8
The standard deviation for stock B is 20.8...........................................................................................10
The standard deviation for the portfolio is 20.71...............................................................................10
1.82........................................................................................................................................................10

8.11
Stocks X and Y have the following probability distributions of expected returns

Probability rx ry
0.10 -10 -35
0.20 2 0
0.40 12 20
0.20 20 25
0.10 38 45

a) Calculate the expected rate of return for stock Y, ry (kx = 12%)

Probability Performance Expected

performance
 0.1 -35 -3.5
0.2 0 0
0.4 20 8
0.2 25 5
m 0.1 45 4.5
1.0 14.00

b) Calculate the standard deviation of the expected returns for stock X (or 20.35%). On the other hand,
calculate the coefficient of variation for action Y.

Is it possible that most investors consider stock Y less risky than stock X? Explain your answer:

Probability Performance Expected

performance

0.1 -10 -1
0.2 2 0.4
0.4 12 4.8
 0.2 20
0.1 38 3.8
1.0 12.00

Standard deviation of the action Y

Return R - expected Sub - total r^2 Probability Total

0.1 0.12 - 0.020 0.0 0.2 0.000
0.2 0.12 0.080 0.0 0.4 0.003
0.4 0.12 0.280 0.1 0.2 0.016
0.2 0.12 0.080 0.0 0.1 0.001
0.1 0.12 - 0.020 0.0 1.0 0.000
Variance 0.019
Standard deviation 0.14

Terry recently invested equal amounts in five stocks to form an investment portfolio, which has a
8.13
beta of 1.2, that is, B = 1.2 Terry plans to sell his risky stocks, which have a beta coefficient of 2, for
one with B = 1. What will be the new beta of your investment portfolio? Suppose you invest equal
amounts of each stock in the portfolio.

Its new beta would be 1.1

If rLR= 9%, rM= 14% and Bx = 1.3

8.16
What is Rx, the required rate of return on stock
to)
rLR= 9%
rM= 14%
rp= x
Bx 1.3

rp= rLR+(rM-rLR)B= 15.50%

The expected return is 15.50%

Now suppose that rLR 1) Increases to 10 percent or 2) decreases to 8 percent. The slope of the LMV
remains constant. How will each change affect rMy Rx?
b)
rLR= 10%
rM= 14%
rp= x
Bx 1.63
 rp= rLR+(rM-rLR)B= 16.5%

The expected return is 16.5%

c) If rLR remains at 9 percent, but rM 1) Increases to 16 percent or 2) decreases to 13 percent. The slope of the
LMV does not remain constant. How would these changes affect Rx?

rLR= 9%
rM= 16%
rp=Bx x
1.3

rp= rLR+(rM-rLR)B= 18.10%

The expected return is 18.10%

rLR= 9%
rM= 13%
rp=Bx x
1.3

rp= rLR+(rM-rLR)B= 14.20%

The expected return is 14.20%

If the market rate increases, the expected return increases, if the market rate decreases the return also
decreases.

8.19 Suppose you manage a $4 million investment fund that consists of four stocks with the following
investments and betas

Action Investment Beta

TO 400,000 1.5
b 600,000 -0.5
c 1,000,000 1.25
d 2,000,000 0.75
4,000,000

If the required market rate of return is 14 percent and the risk-free rate is 6 percent, what is the fund's
required rate of return?

rLR= rM= rp=

6%
14
x %
 Amount invested Beta W.B.
TO 400,000 0.10 1.5 0.15
b 600,000 0.15 -0.5 -0.075
c 1,000,000 0.25 1.25 0.312
d 2,000,000 0.50 0.75 5 0.375
Total= 4000000 Beta = 0.762
rp= rLR+(rM-rLR)B 12.10% 5

The beta is 0.7625

The expected return of the fund is 12.10%

8.2 Information about investment A, investment B and investment C is presented below.

Performance
EC Condition Probability TO b c
Boom 0.5 25 40 5
Normal 0.4 15 20 10
Recession 0.1 5 -40 15
R 18 24
either 23.3 3.3

a) Calculate the expected return, r for investment C

ProbabilityPerformance Expected
performance

0.5 5 2.5
0.4 10 4
0.1 15 1.5
1.0 8.00

The expected return for investment C is 8

b) Calculate the standard deviation, or for investment A

ProbabilityPerformance Expected
performance

0.5 25 12.5
0.4 15 6
0.1 5 0.5
1.0 19.00
Standard deviation of action A
Performance R - expected Sub - total r^2 Probability Total
25.0 19.00 6.000 36.0 0.5 18.000
15.0 19.00 - 4.000 16.0 0.4 6.400
5.0 19.00 - 14.000 196.0 0.1 19.600
Variance 44.000
Standard deviation 6.63

The standard deviation is 6.63

c) Based on the total risk and return, which of the investments would you prefer to invest in risky
stocks?

I would prefer to buy option C, since it has less risk in the purchase.

8.23 Stock A and Stock B have the following historical returns:

Year Performance Performance

Action A Action B
2004 -18 -14.5
2005 33 21.8
2006 15 30.5
2007 0.5 -7.6
2008 27 26.3

a) Calculate the average rate of return for each stock during the period 2004-2008

Year Performance Performance

Action A Action B
2004 -18 -14.5
2005 33 21.8
2006 15 30.5
2007 0.5 -7.6
2008 27 26.3
Total performance 57.5 56.5
average performance 11.5 11.3

The average rate of return for Stock A is 11.5 and the average rate of return for Stock B is 11.3.

Suppose someone manages a portfolio that consists of 50 percent of stock A and 50 percent of
b) stock B. What would have been the rate of return obtained on the portfolio each year from
2004 to 2008?

Year Performance Performance

Action A Action B
2004 -9 -7.25
2005 16.5 10.9
2006 7.5 15.25
2007 0.25 -3.8
2008 13.5 13.15
Total performance 28.75 28.25
average performance 5.75 5.65

The average rate of return for Stock A is 5.75 and the average rate of return for Stock B is 5.65. What
would have been the average return on the portfolio during this period?

The average return on the portfolio would be: 5.7

c) Calculate the standard deviation of the returns for each stock and for the portfolio. Use the
equation 8-4

The expected return is 10% 10

The new beta for the portfolio is 2.06 10
The required rate of return on the stock is 15.50% 10
The expected return is 17% 2
The expected rate of return for the market is 13.50 2
The expected rate of return for the stock is 11.60 2
Standard deviation of the S stock 2
Standard deviation of the action Y 5
Its new beta would be 1.1 5
The expected return is 15.50% 5
16.5% 14
The expected return is 16.5% 14
If the market rate increases, the expected return increases, if the market rate decreases the return
also decreases. 14
The beta is 0.7625 6
The expected return of the fund is 12.10% 6
The expected return for investment C is 8 6
The standard deviation is 6.63 7
I would prefer to buy option C, since it has less risk in the purchase. 7
The average rate of return for Stock A is 11.5 and the average rate of return for Stock B is 11.3. 8
The average rate of return for Stock A is 5.75 and the average rate of return for Stock B is 5.65.
What would have been the average return on the portfolio during this period? 8
The average return on the portfolio would be: 5.7 8
The standard deviation for stock B is 20.8. 10
The standard deviation for the portfolio is 20.71 10
1.82 10

57.5
11.5

870.25 462.25 12.25 121 240.25 =

4

1706 = 426.5 20.7

4

The standard deviation for stock A is 20.7

 Performance
Action B
2004 -14.5
2005 21.8
2006 30.5
2007 -7.6
2008 26.3
Year 225
665.64 110.25 368.64 357.21
4

1727 431.69 20.8

4

56.5
11.3
The standard deviation for stock B is 20.8.

The standard deviation for the portfolio is 20.71

d) Calculate the deviation coefficient for each stock and for the portfolio

Action A
CV = Risk / Standard deviation r 20.65 1.80
Performance 11.50

Action B
20.78 1.84
11.30

Briefcase
20.71
1.82
11.40

a If you were a risk-averse investor, would you prefer to buy stock A, stock B, or the portfolio?
Because ?
n

I would prefer to buy option A, since there is less risk in the purchase.