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    Investment and Portfolio Management Session 3 Solutions

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    李佳南
    The document discusses portfolio risk and return, including: 1) Calculating the mean, variance, and standard deviation of a portfolio's expected returns under different scenarios. 2) The holding period return is calculated for each scenario and the expected return, variance, and standard deviation are determined. 3) Time-weighted average returns are calculated for a portfolio over three years and the arithmetic and geometric means are presented. 4) A dollar-weighted return is calculated based on the internal rate of return that sets the net present value of cash flows to zero.

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    Investment and Portfolio Management Session 3 Solutions

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    李佳南
    26 views3 pages
    The document discusses portfolio risk and return, including: 1) Calculating the mean, variance, and standard deviation of a portfolio's expected returns under different scenarios. 2) The holding period return is calculated for each scenario and the expected return, variance, and standard deviation are determined. 3) Time-weighted average returns are calculated for a portfolio over three years and the arithmetic and geometric means are presented. 4) A dollar-weighted return is calculated based on the internal rate of return that sets the net present value of cash flows to zero.

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    Investment and Portfolio management Session 3 solutions

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    Investment and Portfolio management Session 3 solutions

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    The document discusses portfolio risk and return, including: 1) Calculating the mean, variance, and standard deviation of a portfolio's expected returns under different scenarios. 2) The holding period return is calculated for each scenario and the expected return, variance, and standard deviation are determined. 3) Time-weighted average returns are calculated for a portfolio over three years and the arithmetic and geometric means are presented. 4) A dollar-weighted return is calculated based on the internal rate of return that sets the net present value of cash flows to zero.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    26 views3 pages

    Investment and Portfolio Management Session 3 Solutions

    Uploaded by

    李佳南
    The document discusses portfolio risk and return, including: 1) Calculating the mean, variance, and standard deviation of a portfolio's expected returns under different scenarios. 2) The holding period return is calculated for each scenario and the expected return, variance, and standard deviation are determined. 3) Time-weighted average returns are calculated for a portfolio over three years and the arithmetic and geometric means are presented. 4) A dollar-weighted return is calculated based on the internal rate of return that sets the net present value of cash flows to zero.

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    of 3

    TUTORIAL SOLUTIONS – WEEK 4

    Session 3 Topic

    ‘5 Using Equation 5.10, we can calculate the mean of the HPR as:
    𝑆𝑆
    E(r) = �𝑠𝑠=1 p(s) r(s) = (0.3 × 0.44) + (0.4 × 0.14) + [0.3 × (–0.16)] = 0.14 or 14%
    Using Equation 5.11, we can calculate the variance as:
    𝑆𝑆
    Var(r) = σ2 = �𝑠𝑠=1 p(s) [ r(s) – E(r)]2

    = [0.3 × (0.44 – 0.14)2] + [0.4 × (0.14 – 0.14)2] + [0.3 × (–0.16 – 0.14)2]


    = 0.054
    SD(r) = σ = �Var(r) = √0.054 = 0.2324 or 23.24% [Standard Deviation]

    ‘6 We use the below equation to calculate the holding period return of each scenario:
    Ending Price － Beginning Price + Cash Dividend
    HPR =
    Beginning Price
    a. The holding period returns for the three scenarios are:
    Boom: (50 – 40 + 2)/40 = 0.30 = 30%
    Normal: (43 – 40 + 1)/40 = 0.10 = 10%
    Recession: (34 – 40 + 0.50)/40 = –0.1375 = –13.75%
    𝑆𝑆
    E(HPR) = �𝑠𝑠=1 p(s) r(s)

    = [(1/3) × 0.30] + [(1/3) × 0.10] + [(1/3) × (–0.1375)]


    = 0.0875 or 8.75%
    𝑆𝑆
    Var(HPR) = �𝑠𝑠=1 p(s) [ r(s) – E(r)]2

    = [(1/3) × (0.30 – 0.0875)2] + [(1/3) × (0.10 – 0.0875)2]


    + [(1/3) (–0.1375 – 0.0875)2]
    = 0.031979
    SD(r) = σ = �Var(r) = 319.79 = 0.1788 or 17.88%

    b. E(r) = (0.5 × 8.75%) + (0.5 × 4%) = 6.375%


    σ = 0.5 × 17.88% = 8.94%

    ‘7 Time-weighted average returns are based on year-by-year rates of return.

    Year Return = [(Capital gains + Dividend)/Price]


    2016 (110 – 100 + 4)/100 = 0.14 or 14.00%
    2017 (90 – 110 + 4)/110 = –0.1455 or –14.55%
    2018 (95 – 90 + 4)/90 = 0.10 or 10.00%
    Arithmetic mean: [0.14 + (–0.1455) + 0.10]/3 = 0.0315 or 3.15%
    Geometric mean: �(1
    3
    + 0.14) × [1 + (–0.1455)] × (1 + 0.10) – 1
    = 0.0233 or 2.33%

    Net Cash Flow –300 –208 110 396

    Time Net Cash flow Explanation


    0 –300 Purchase of three shares at $100 per share
    1 –208 Purchase of two shares at $110,
    plus dividend income on three shares held
    2 110 Dividends on five shares,
    plus sale of one share at $90
    3 396 Dividends on four shares,
    plus sale of four shares at $95 per share

    The dollar-weighted return is the internal rate of return that sets the sum of the
    present value of each net cash flow to zero:
    –$208 $110 $396
    0 = –$300 + + +
    1+ IRR (1+ IRR) 2
    (1+ IRR)3
    Dollar-weighted return = Internal rate of return = –0.1661%

    Question 11

    a. The expected cash flow is: (0.5 × $50,000) + (0.5 × $150,000) = $100,000
    With a risk premium of 10%, the required rate of return is 15%. Therefore, if
    the value of the portfolio is X, then, in order to earn a 15% expected return:
    Solving X × (1 + 0.15) = $100,000, we get X = $86,957

    b. If the portfolio is purchased at $86,957, and the expected payoff is $100,000,


    then the expected rate of return, E(r), is:
    $100,000 − $86,957
    = 0.15 = 15%
    $86,957
    The portfolio price is set to equate the expected return with the required rate
    of return.

    c. If the risk premium over T-bills is now 15%, then the required return is:
    5% + 15% = 20%
    The value of the portfolio (X) must satisfy:
    X × (1 + 0.20) = $100, 000 ⇒ X = $83,333
    d. For a given expected cash flow, portfolios that command greater risk premiums
    must sell at lower prices. The extra discount in the purchase price from the
    expected value is to compensate the investor for bearing additional risk.
    ’17. Assuming no change in tastes, that is, an unchanged risk aversion, investors
    perceiving higher risk will demand a higher risk premium to hold the same portfolio they
    held before. If we assume that the risk-free rate is unaffected, the increase in the risk
    premium would require a higher expected rate of return in the equity market.

    ’18. Expected return for your fund = T-bill rate + risk premium = 6% + 10% = 16%
    Expected return of client’s overall portfolio = (0.6 × 16%) + (0.4 × 6%) = 12%
    Standard deviation of client’s overall portfolio = 0.6 × 14% = 8.4%

    CFA 3
    Answer: c. Determines most of the portfolio’s return and volatility over time.

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