You expect TAS stock to have a 12% return next year and a 30% volatility. You have $5,000 to invest but plan to invest a total of $12,500 in TAS, raising the additional $7,500 by shorting either FEM or BNE stock. Both FEM and BNE have an expected return of 10% and a volatility of 20%. If FEM has a correlation of 0.3 with TAS, and BNE has a correlation of −0.30 with TAS. Use calculations to show which stock you should short to minimize your investment risk. How about your portfolio return in two different investment strategies?
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.
You expect TAS stock to have a 12% return next year and a 30% volatility. You have $5,000 to invest but plan to invest a total of $12,500 in TAS, raising the additional $7,500 by shorting either FEM or BNE stock. Both FEM and BNE have an expected return of 10% and a volatility of 20%. If FEM has a correlation of 0.3 with TAS, and BNE has a correlation of −0.30 with TAS. Use calculations to show which stock you should short to minimize your investment risk. How about your portfolio return in two different investment strategies?
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