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Finance:Portfolio return, standard deviation.

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5.13 in Ch. 5

Expected return
Year Stock L Stock M

2010 14% 20%
2011 14 18
2012 16 16
2013 17 14
2014 17 12
2015 19 10

P5â?"13 Portfolio return and standard deviation Jamie Wong is considering building an investment portfolio containing two stocks, L and M. Stock L will represent 40% of the dollar value of the portfolio, and stock M will account for the other 60%. The expected returns over the next 6 years, 2010â?"2015, for each of these stocks are shown in the following table:

a. Calculate the expected portfolio return, rp, for each of the 6 years.

b. Calculate the expected value of portfolio returns, , over the 6-year period.

c. Calculate the standard deviation of expected portfolio returns, rp, over the
6-year period.

d. How would you characterize the correlation of returns of the two stocks L and M?

e. Discuss any benefits of diversification achieved by Jamie through creation of the portfolio.

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Solution Summary

The problem set deal with topics in finance: Portfolio management.

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Bond vs stock indices; expected portfolio return; standard deviation of a portfolio

1. Why are bond market indices more difficult to construct and maintain than stock market indices?

2. An investor wishes to construct a portfolio consisting of a 70% allocation to a stock index and a 30% allocation to a risk free asset. The return on the risk-free asset is 4.5% and the expected return on the stock index is 12%. The standard deviation of returns on the stock index 6%. Calculate the expected return on the portfolio and the expected standard deviation of the portfolio.

Asset (A) Asset (B)
E(RA) = 16% E(RB) = 10%
(sA) = 9% (sB) = 7%
WA = 0.5 WB = 0.5

COVA,B = 0.0009

a. What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (si), covariance (COVi,j), and asset weight (Wi) are as shown above?

b. What is the standard deviation of this portfolio?

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