Cailin Chen Question 9: (10 Points)

Cailin Chen
Question 9: (10 Points)

1. A portfolio consists of the following securities:
Std.
Beta
Security Amount Invested Dev.
βi
σi
A $250,000 15.50 1.45
B $350,000 8.35 0.75
C $200,000 21.22 1.85
D $150,000 7.75 0.45
E $50,000 13.75 1.25
What is the portfolio’s beta? Is the portfolio riskier than the market? Explain.
2. An investor’s portfolio two risky-asset portfolio is allocated as follows:
Asset Type Amount Invested Standard Deviation Expected Return
Bonds $45,000 15% 6.5%
Stocks $55,000 22% 14.0%
The correlation coefficient between the two assets is zero (ρ b, s = 0). Based on this
information, calculate the portfolio’s variance of returns (σ2p), standard deviation (σp), and
expected return E (Rp).
3. The realized returns for the common stock of Company X are given as follows:
2009 2010 2011 2012 2013
5.3% 15.5% -35.0% 25.2% 12.7%

Based on this information calculate the stock’s average return, variance of returns, and
standard deviation.
Portfolio beta solution 1:
It is computed in a tabular form with formulas:
Std.
Amount Dev. Beta Weights= invest/total Porfolio beta(weights*
Security Invested σi βi investment beta)
A $250,000 15.5 1.45 0.25 0.3625
B $350,000 8.35 0.75 0.35 0.2625
C $200,000 21.22 1.85 0.2 0.37
D $150,000 7.75 0.45 0.15 0.0675
E $50,000 13.75 1.25 0.05 0.0625
$1,000,000 Porfolio beta 1.125
The portfolio is riskier to market as the portfolio beta is more than 1 .Higher the beat higher the
risk of the portfolio
Solution 2:
Amount Standard Variance

Asset Investe Deviatio Expecte WEight Expecte Differenc = square
Type d n d Return s d return e Square *prob
Bond 0001701562 $0.0007

s $45,000 15% 6.50% $0.45 $0.03 -$0.04 5 7
Stock 0001139062 $0.0006

s $55,000 22% 14.00% $0.55 $0.08 $0.03 5 3
Portfolio $0.0013
$0.11 variance 9
To compute the portfolio S.D = weight ^2 * variance ^2 + weight^2 * variance ^2 + 2* (0)

because correlation is zero
= .45^2 *.00077^2 + .55^2 *.00063^2
= .00024
Solution 3:
Year return Difference Square
2009 5.30% 0.56% 0.0031%
2010 15.50% 10.76% 1.1578%
2011 -35.00% -39.74% 15.7927%
2012 25.20% 20.46% 4.1861%
2013 12.70% 7.96% 0.6336%
Average return 0.0474 Variance 21.7733%
S.d = SQRT variance / n-1
= SQRT (.0544)
S.D = .233
Question 10: (10 Points)

1. Use the following scenario analysis for Stocks X and Y:
Scenario Description Probability of Expected Expected

Occurrence Outcome (HPR) Outcome (HPR)
Stock X Stock Y
1 Bear Market .25 -5.5% -10.5%
2 Normal Market .45 6.0% 8.0%
3 Bull Market .30 11.5% 18.5%
Based on this information:

a. Calculate the expected returns for Stocks X and Y.
b. Calculate the standard deviations of returns on Stocks X and Y.
c. Which stock is riskier? Explain your answer. Hint: You may want to interpret and compare the
standard deviation for each stock.
d. Assume that 90% of your $100,000 portfolio is invested in Stock X, while the rest (or 10%) is
invested in Stock Y. What is the expected return of your portfolio?
2. Use the CAPM to calculate the required rate of return (expected return) to Stock X if: the risk-
free rate of return is 4%, the expected return of the market is 12% and the stock’s beta
coefficient is 1.25. What is the stock’s alpha if its actual return was 12.5%? Is the stock
overpriced or underpriced? Explain.
a.Expected returns for Stocks X and Y.
Stock X E(R ) = (0.25*-0.055)+(0.45*0.06)+(0.3*0.115) = -0.01375+0.027+0.0345 = 0.04775 or

4.775%
Stock Y E(R ) = (0.25*-0.105)+(0.45*0.08)+(0.3*0.185) = -0.02625+0.036+0.0555 = 0.06525 or

6.525%
b. Standard deviations of returns on Stocks X and Y.
Variance Stock X = 0.25(-0.055-0.04775)+0.45(0.06-0.04775)+ 0.3(0.115-0.04775)

=000263939+000006750+000135677=000406366
Standard deviation Stock X= 000406366)^0.5 =006374684 or 6.37%
Variance Stock Y = 0.25(-0.105-0.06525)+0.45(0.08-0.06525)+ 0.3(0.185-0.06525)

=000724627+000009810+000430202 = 001164638
Standard deviation Stock Y= 001164638)^0.5 =01079184 or 10.79%

c. Which stock is riskier?
Stock Y is more risker as it has Standard deviation of 10.79% compare to stock X 6.37%.
d. Assume that 90% of your $100,000 portfolio is invested in Stock X, while the rest (or 10%) is
invested in Stock Y.
Expected return of your portfolio =( 0.9 *0.04775) +(0.1*0.06525) = 0.0495 or 4.95%
2.Using CAPM
E(R) = Rf+Beta (Rm- Rf)
= 4% +1.25 ( 12%-4%)
= 14%
Stock’s alpha if its actual return was 12.5% = 12.5% -14% = -1.5%
Stock X is undervalued since forcasted return is higher than actual return.

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Cailin Chen

Question 9: (10 Points)

A $250,000 15.50 1.45

B $350,000 8.35 0.75

C $200,000 21.22 1.85

D $150,000 7.75 0.45

E $50,000 13.75 1.25

Asset Type Amount Invested Standard Deviation Expected Return

Bonds $45,000 15% 6.5%

Stocks $55,000 22% 14.0%

2009 2010 2011 2012 2013

5.3% 15.5% -35.0% 25.2% 12.7%

It is computed in a tabular form with formulas:

A $250,000 15.5 1.45 0.25 0.3625

B $350,000 8.35 0.75 0.35 0.2625

C $200,000 21.22 1.85 0.2 0.37

D $150,000 7.75 0.45 0.15 0.0675

E $50,000 13.75 1.25 0.05 0.0625

$1,000,000 Porfolio beta 1.125

Amount Standard Variance

Bond 0001701562 $0.0007

Stock 0001139062 $0.0006

To compute the portfolio S.D = weight ^2 * variance ^2 + weight^2 * variance ^2 + 2* (0)

= .45^2 *.00077^2 + .55^2 *.00063^2

Year return Difference Square

2009 5.30% 0.56% 0.0031%

2010 15.50% 10.76% 1.1578%

2011 -35.00% -39.74% 15.7927%

2012 25.20% 20.46% 4.1861%

2013 12.70% 7.96% 0.6336%

Average return 0.0474 Variance 21.7733%

S.d = SQRT variance / n-1

Question 10: (10 Points)

Scenario Description Probability of Expected Expected

1 Bear Market .25 -5.5% -10.5%

2 Normal Market .45 6.0% 8.0%

3 Bull Market .30 11.5% 18.5%

Based on this information:

Stock X E(R ) = (0.25*-0.055)+(0.45*0.06)+(0.3*0.115) = -0.01375+0.027+0.0345 = 0.04775 or

Stock Y E(R ) = (0.25*-0.105)+(0.45*0.08)+(0.3*0.185) = -0.02625+0.036+0.0555 = 0.06525 or

b. Standard deviations of returns on Stocks X and Y.

Variance Stock X = 0.25(-0.055-0.04775)+0.45(0.06-0.04775)+ 0.3(0.115-0.04775)

Standard deviation Stock X= 000406366)^0.5 =006374684 or 6.37%

Variance Stock Y = 0.25(-0.105-0.06525)+0.45(0.08-0.06525)+ 0.3(0.185-0.06525)

Standard deviation Stock Y= 001164638)^0.5 =01079184 or 10.79%

Expected return of your portfolio =( 0.9 *0.04775) +(0.1*0.06525) = 0.0495 or 4.95%

E(R) = Rf+Beta (Rm- Rf)

Stock X is undervalued since forcasted return is higher than actual return.

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= .45^2 .00077^2 + .55^2 .00063^2

Stock X E(R ) = (0.25-0.055)+(0.450.06)+(0.3*0.115) = -0.01375+0.027+0.0345 = 0.04775 or

Stock Y E(R ) = (0.25-0.105)+(0.450.08)+(0.3*0.185) = -0.02625+0.036+0.0555 = 0.06525 or

Expected return of your portfolio =( 0.9 0.04775) +(0.10.06525) = 0.0495 or 4.95%