Portfolio Theory

Suppose Asset A has an expected return of 10 percent and a standard deviation of 20 percent. Asset B

Billy should a diversified portfolio, but buy more health and technology stocks because they are at low prices and are more bullish. For example, IBM is at $149.25. The 52 week low is 116.9 and the 52 week high is 176.3. If Billy buys 10 shares, he should have at least a 2% (total purchase price ÷ money gained/loss x 100) expected return on the stocks. If Billy buys 10 shares of JNJ at $108.97, he would get at least 3% return. The 52 week low for JNJ is 81.79 and the 52 week high is 109.84. This shows that JNJ is closer to its high, so Billy would most likely make a dividend off of

Answer: The standard deviation can be calculated by subtracting the expected return from the actual return for each year and squaring the results. The squares are summed, and divided by the number of observances minus 1. The square root of that result is the standard deviation.

E.g. A combination of investments in Umbrellas and Ice Creams will eliminate the risk of one another, i.e., the low returns from ice creams in rainy season will be compensated by the umbrella sales. High returns in one industry, in this case, always offset low returns in the other to give a positive return with certainty because returns on the two assets are inversely correlated.

A and C will offer the same mean return yet less variance than B. This is pictured

(a) The mean excess return, standard deviation, and portfolio weights for the minimum variance portfolio.

Portfolio Return of a portfolio with two stocks (Stock A and Stock B) is given by following formula:

(1) Calculate the expected return (rp), the standard deviation (p), and the coefficient of variation (CVp) for this portfolio and fill in the appropriate blanks in the table.

In this case, the Partner’s Treasury Department has computed all the portfolios for minimum level of risk with different types of assets, more specifically, adding Real Estate Investment Trusts (REITs), Commodities or both, from an undefined approach. Since the results are identical as calculated from Mean-Variance Theory, they should be the optimal portfolios for each target level of return. Therefore a graph with efficient frontier, which represents the optimal portfolios with different assets, is constructed based on Exhibit 5 to 8 for comparison. [Appendix B] Technically, any portfolio on the efficient frontier is an optimized portfolio and is indifferent from each other in terms of risk/return trade off.

portfolio change if you assume a correlation between GE and GM of 0.80 or –0.80?

Many portfolios are managed to a benchmark, normally an index. Some portfolios are expected to replicate, before trading and other costs, the returns of an index exactly (an index fund), while others are expected to 'actively manage' the portfolio by deviating slightly from the index in order to generate active returns or

CAPM results can be compared to the best expected rate of return that investor can possibly earn in other investments with similar risks, which is the cost of capital. Under the CAPM, the market portfolio is a well-diversified, efficient portfolio representing the non-diversifiable risk in the economy. Therefore, investments have similar risk if they have the same sensitivity to market risk, as measured by their beta with the market portfolio.

d. What would be the investor 's certainty equivalent return for the optimally chosen combination? 2. Consider an investor who has an asset allocation of 50% in equities and the rest in T-Bills. Suppose the expected rate of return on equities is 10%/year and the standard deviation of the return on equities is 15%/year. T-Bills earn 6%/year. a. What is the implied risk aversion coefficient of the investor?

Depending on whether believing in the Efficiency Market Hypothesis, portfolio strategies are classified as either active strategies or passive portfolio strategies. Active portfolio strategy doesn’t believe Efficiency Market Hypothesis, it uses available information and forecasting techniques to seek better performance than the average market, the aim of this strategy is also known as ‘beat the market’. Whereas passive portfolio strategy treats the market as efficient and believes it is not possible to beat the market returns

In 1952 the basic concept of the modern portfolio theory was written by Harry Markowitz, in which he explained that assets in an investment portfolio are not only to be selected on the basis of its merit but also by how it’s price changes relative to every other asset in the portfolio. Investment can be stated as a trade-off between expected return and risk, the riskier the investment the higher the return and vice versa. It allows us to make a decision to choose between the portfolio with either the highest rate of return or the lowest amount of risk. The risk of different stocks can be reduced if a portfolio consists of stocks with different risks and returns for example; if stock A has high risk and stock B has low risk, the overall portfolio risk is less, as it is the weighted average of both risks. Owning different shares with different risks in a portfolio is known as diversification. Markowitz hence developed the efficient frontier of portfolio, the efficient set in which investors choose the most suitable portfolio for them. This concept gave birth to the Capital asset pricing model by William Sharpe in 1964 and linter 1965; they state that there are two types of risk, systematic risk and unsystematic risk. The former is the market risk that cannot be diversified while the latter is the risk associated with individual stocks which can be reduced through diversification as stated by the MPT (Investopedia, 2003) Investors basically invest by delaying consumption now