0000002372 00000 n Probability Possible rate of return 0.25 0.09 %PDF-1.3 If the portfolio is comprise of 40% X and 60% Y and if the correlation between the returns on X and Y is -0.25, what is the portfolio’s expected return and risk? Risk and Return: Portfolio Theory and Asset Pricing Models ANSWERS TO END-OF-CHAPTER QUESTIONS The expected return – beta relationship is the implication of the CAPM that security risk premiums (expected excess returns) will … 0000005336 00000 n Open spreadsheet. Portfolio risk is increasingly dependent on the covariance of returns. 0000006738 00000 n The data has been collected in the Microsoft Excel Online file below. << /Length 5 0 R /Filter /FlateDecode >> You will get 30 minutes to complete the test. Expected returns Portfolio risk Portfolio 1 23.20% 9.9% Portfolio 2 19.20% 10.0%. If markets are efficient, the price reflects 0000001558 00000 n Define systematic risk. Also The Expected Return On The Market Portfolio Is 15 Percent. The risk-return relationship will now be measured in terms of the portfolio’s expected return and the portfolio… Individual ... it complicates the task of constructing portfolios with ‘efficient’ risk return trade-off due to the growth of possible asset combinations. 0000001420 00000 n 0000003371 00000 n Portfolio risk and return Prepared by Pamela Peterson Drake, Ph.D., CFA 1. 1. Questions have also been Risk of Portfolio of Two Assets: The risk of a security is measured in terms of variance or standard deviation of its returns. 0979. A portfolio comprises two securities and the expected return on them is 12% and 16% respectively. Section 3 deals with the impact of diversification on portfolio risk. The beta is a relative measure of systematic risk. 2. 0000001213 00000 n The price Question: (Graphical representation systematic and unsystematic risk) In the examiners ‘Questions and Answers’ for May 2010, question four (a) required a diagram illustration for systematic and unsystematic risks. The portfolio risk is not simply a measure of its weighted average risk. <<9677f80f1c0983448a384dbcca936b1d>]>> %��������� Explain Markowitz Portfolio Theory? Since the return of a portfolio is commensurate with the returns of its individual assets, the return of a portfolio is the weighted average of the returns of its component assets.The dollar amount of an asset divided by the dollar amount of the portfolio is the weighted average of the asset and the sum of all weighted averages must equal 100%. The risk premium of an asset is proportional to its beta. Question: RISK AND RETURN You Own A Portfolio Consisting Of The Following Stocks. The weight attached to an asset = market value of asset/market value of portfolio. 1420 0 obj<>stream The securities consisting in a portfolio are associated with each other. 0000000016 00000 n methods of investment analysis and portfolio formation, stocks and bonds analysis and valuation for investment decision making, options pricing and using as investments, asset allocation, portfolio rebalancing, and portfolio performance measures. portfolioZwith expected return 9%, standard deviation 21% X dominates Z; it has higher reward but lower risk (III) An investor using the Mean-Variation Criterion: b. may concentrate all investments in Security B (IV) John and Jim are both risk averse and only care about the mean and standard deviation of their portfolio’s return. a. • Summaries, Key-terms, Questions and problems are provided at the end of 0000008875 00000 n Once we have risk and return for individual securities, we can then calculate portfolio risk and return. Example %%EOF the same portfolio of risky securities is a result of: (a) diminishing marginal utility of income (b) covariance (c) the separation theorem (d) the normal distribution assumption 3. portfolio components, so there is no enhancement of portfolio return. 3. a) 12.4% b) 13.4% c) 14.4% d) 15.4% View Answer / Hide Answer 0000004694 00000 n 0000008097 00000 n Portfolio return is 12.98%. a. total return … total risk b. expected return … total risk c. total return … systematic risk d. expected return … systematic risk 13. Risk and return questions and practice problems Risk and return part 2: Questions 1. x�]K��Ƒ��W�e#�A�G��lP��� ɢ�q�`� �Cr�yP����_�?�_�_f�Q]��e#��*__=P����~s}���ڵ��?�O�pqw9�?7�닋�U����۽|1�����}yn�����w$���Oϊ�W�����������/�m�L!��Y1�����]����b��7u]�]�5�[�M���}��]�mM\[�UuL�+��s!��������ҭ_B/t�dl��zO��-ݡߠ�έ�Tݠ����4pqO��5���W=���+�GkW���+w�7e��v�r����� ��Uy�>���ZE'©�)5�U}�5M��������׿ʟW����g�8~�n����I ��T�b4V]�hl����\��CD|��ݻ@������D���{'���O!�n>�DZ�)��$�[wu��$N�"2ؙ,SH���Dc��՝��U������ �����mU�Mӷ4L�^��?�����:L�oߺ�W��!g\����;�r���&:�weU�j�1��.��MU���D�c�uH� �־~M�Y��&/v7_4��xe����.�uG� =��eL{w���qkBz�5��v�w]��6#ߵ͘�2���F�GN�@���B���1�F�dXU�T���1��[2��Y��uUyTW�3��. ... Let us now assume investments can be combined into a two-asset portfolio. x���1 0ð4\ 0000000873 00000 n answers you are looking at involve the examiner having algebraically-rearranged the formulae found on this sheet. ∴ Portfolio return is 12.98%. {\G����M�ѕ�y�C. First we turn our attention to the concept of expected return. Risk and Return Problems and Solutions is set of questions and answers for risk and expected return and its associated cash flows. 0000003621 00000 n c. Risk on Portfolio: The risk of a security is measured in terms of variance or standard deviation of its returns. 0000009547 00000 n 10 Key Points To Remember. i) Tax risk j) Etc 4. When combining risk though, there is a reduction in portfolio risk relative to the weighted average of the component ... All of the answers indicate that the higher risk exposure is the in Subsidiary A. Visit the post for more. startxref 0000010277 00000 n 0000002905 00000 n Susan is expecting the returns on the market portfolio to be negative in the near term. 8. By investing in a variety of assets, this unique portion of the total risk can be eliminated at little cost. Find the portfolio return and risk Answer. Stock Percentage Of Portfolio (%) Beta Expected Return (%) A 20 1 15 B 30 0.85 13 C 50 1.20 10 The Risk Free Is 6 Percent. Portfolio 1 is the most efficient portfolio as it gives us the highest return for the lowest level of risk. Questions and Answers ... CFA, is an analyst with a large money management firm. There are 20 questions in this test from the Portfolio Management section of the CFA Level 1 syllabus. endstream endobj 1443 0 obj<>/W[1 1 1]/Type/XRef/Index[56 1361]>>stream ... “Existing investment portfolio: aggressive Findings of risk-profiling questionnaire: conservative” The returns and the risk of the portfolio depending on the returns and risks of the individual stocks and their corresponding shares in the portfolio. The rate of return on the annuity is the same as the rate of return on US T-Bills. book Risk and Portfolio Analysis: principles and methods is not yet fully complete. 0000038699 00000 n �����]�y�*n~/M�Ev�3��X�`������І�Av��j���������V3t�8e�[�K6���e`6lˠ�Ao҈��9�*z�gzN����Uhi��� RISK AND RETURN This chapter explores the relationship between risk and return inherent in investing in securities, especially stocks. 0000002012 00000 n stream 4 0 obj Within the framework of modern portfolio theory, if portfolios A and B have the same return but portfolio A has less risk, then: Overview Security analysts and portfolio managers are concerned about an investment’s return, its risk, and whether it is priced correctly by the market. Answer. The portfolio risk is not simply a measure of its weighted average risk. sponding suggested answers. 0000003948 00000 n Determine return of portfolio if first security constitutes 40% of total portfolio. Solutions to risk and return practice problems 4 . View Test Prep - Risk and Return Practice Problems with Solutions.pdf from BA D1 at Brenau University. 0000007867 00000 n Portfolio expected return is the sum of each of the individual asset’s expected return multiplied by its associated weight. CHAPTER 11 RISK AND RETURN: THE CAPITAL ASSET PRICING MODEL (CAPM) Answers to Concept Questions 1. The risk-free rate is 5.5%, and the market is in equilibrium. 0000003333 00000 n Following are the probability distribution of returns of portfolio of Stock A and Stock B in equal proportion of weight in each state of economy. On the other hand, there are some risks that affect all investments. This result occurs because returns on A and B are not perfectly positively correlated (ρAB = 0.88). 0000007457 00000 n trailer b. Some of the risk in holding any asset is unique to the asset in question. Thus: E(R p) = ΣW i R i where i = 1,2,3 … n. Where W i represents the weight attached to asset I and R i is the asset’s return. CHAPTER 1 Exercise 1.1. 0000001869 00000 n The possible rate of return for a portfolio for an investment is shown below. The concepts of systematic and unsystematic risk are introduced here. 0000012948 00000 n (That is, required returns equal expected returns.) Our final step would be the plot of the risk and return combined metric, return per unit of risk, which plots the portfolio risk and return for different values of portfolio allocation. Describe the CAPM and explain what it does. 0 Illustration 16.2: Compute the risk return characteristic of an equally weighted portfolio of three securities whose individual risk and return are given in the following table. The portfolio return r p = 0.079 with the risk σ p = 0. Please inform us if you spot any errors. %PDF-1.5 %���� 5. The above can be checked with the capital weightage formulas for the minimum variance (risk).Substituting xref 1417 27 It is of little use to investors who wish to earn large returns. Mean portfolio return 12% Var(P) 0.00845 sd(P) 9.2% • The risk of the portfolio is lower than the risk of either of the two stocks! It can greatly increase the risk of a portfolio. We will suggest, as did H. Harkowitz in 1952, that the standard deviation of portfolio returns be used as a measure of total portfolio risk. He also derived a formula for computing the variance/SD of a portfolio. • The expected return on a portfolio is given by the weighted average returns of the two assets RP =XARA +XBRB • The variance of returns of a portfolio is given by σP XAσA XBσB 2XAXBσAB 2 = 2 2 + 2 2 + What is the market risk premium (r M - r RF)? A risk-averse investor would choose the portfolio over either Stock A or Stock B alone, since the portfolio offers the same expected return but with less risk. What is the most true regarding diversification? ���s��6?Y��V#P9l`�'��R؃K�ӽ�N��_�RV*�yU���[���\��C�X��9�Ɂ�KzN�ْ�P�+��YJ����� � �V"�P�uw��0l0 the concept of portfolio risk. Open the spreadsheet and perform the required analysis to answer the questions below. Since she is managing a stock mutual fund, she must remain invested in a portfolio of stocks. The securities consisting in a portfolio are associated with each other. In what follows we’ll define risk and return precisely, investi-gate the nature of their relationship, and find that there are ways to limit exposure to in-vestment risk. Expected return = 0.4(0.05) + 0.6(0.15) = 0.02 + 0.09 = 0.11 or 11% Portfolio risk is what matters to investors and portfolio risk is what governs the risk premiums they demand. (Arbitrage in bond prices) (a) The cash flow of Bond D can be generated by the portfolio consisting of 106=200 units of Bond C, 6=102 units of Bond B and (6 12=102)=100 units of Bond A. 0000003870 00000 n • Markowitz showed that the variance of the rate of return was a meaningful measure of portfolio risk under a reasonable set of assumptions. 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