return and standard deviation of Netflix (NFLX) stock were 3.5% and 10%, respectively. For the same period, the monthly average return and standard deviation of Verizon (VZ) were 0.6% and 4.6%, respectively. The correlation between NFLX and VZ was -0.1. Assume that the monthly risk-free rate is 0.1%. ) What is the Sharpe ratio for NFLX? What is the Sharpe ratio for VZ? Show your calculation steps briefly and clearly. Find the minimum-variance portfolio (MVP), i.e., the weight of NFLX and VZ in the MVP. You do not need to show your calculation steps for this subquestion. Find the optimal risky portfolio P*, i.e., the weight of NFLX and VZ in P*. You do not need to show your calculation steps for this subquestion.
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
During the past 5-year, the monthly average return and standard deviation of Netflix (NFLX) stock were 3.5% and 10%, respectively. For the same period, the monthly average return and standard deviation of Verizon (VZ) were 0.6% and 4.6%, respectively. The correlation between NFLX and VZ was -0.1. Assume that the monthly risk-free rate is 0.1%.
- ) What is the Sharpe ratio for NFLX? What is the Sharpe ratio for VZ?
- Show your calculation steps briefly and clearly.
- Find the minimum-variance portfolio (MVP), i.e., the weight of NFLX and VZ in the MVP.
- You do not need to show your calculation steps for this subquestion.
- Find the optimal risky portfolio P*, i.e., the weight of NFLX and VZ in P*.
- You do not need to show your calculation steps for this subquestion.
- Calculate the Sharpe ratio for the optimal risky portfolio P*. Verify that P* offers a higher Sharpe ratio than NFLX and VZ.
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