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Question 1
The Risk Premium is defined as the difference between the Stock Market Return and The TBill
Return
So, we get these results
Year
Risk Premium
1999
18.9%
2000
16.8%
2001
14.8%
2002
22.6%
2003
30.6%
The Average Risk Premium is the arithmetic average of these numbers. It is 0.94%
To calculate the Standard Deviation of the Risk Premium, we first need to determine the square
deviations from the average risk premium, every year
Year
Deviation from Mean
Squared Deviation
1999
19.84%
393.6256
2000
15.86%
251.5396
2001
13.86%
192.0996
2002
21.66%
469.1556
2003
31.54%
994.7716
Sum
2301.192
Then, we pick the sum of the squared deviations and divide by FOUR (not five, because we are
using historical data, we need to divide by the number of observation minus one) to get the
variance. The square root of the variance is the standard deviation. The number is 23.99%
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View Full Document Question 2
In this question all you are required to do is to make portfolios combining the portfolio Mr.
Edwards already has with the Indexes you can choose from. You will make portfolios where 50%
is the old portfolio and 50% will be the index. Notice that, the portfolio is worth $2 million and
the money he has to invest in the indexes is $2 million also.
In the question, the requirement is that the new portfolio has a higher expected return and a lower
standard deviation of returns.
The results are the following
Using Index
Expected Return
Standard Deviation
A
14.4%
21.18%
B
12.4%
20.17%
C
14.9%
23.44%
D
13.9%
21.39%
Using Index B is not good, because expected return is reduced. Using Index C is not good
because Standard Deviation is increased. You can suggest using either Indexes A or D.
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This note was uploaded on 03/30/2011 for the course FIN 5514 taught by Professor Jaffe during the Three '11 term at University of New South Wales.
 Three '11
 jaffe

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