Exercise #7

Exercise #7 - The portfolio variance and the standard...

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1 Finance 355: Investments Instructor: Shuming Liu In-Class Exercise 7 The following portfolio has 50% in stock A and 25% in each of stock B and C. What is the portfolio expected return and portfolio variance and standard deviation? State of Economy Probability of State of Economy Stock A Returns Stock B Returns Stock C Returns Boom 0.5 10% 15% 20% Bust 0.5 8 4 0 ANSWER: Based on States The portfolio return when the economy booms Rp = 0.5 × 10% + 0.25 × 15% + 0.25 × 20% = 13.75% The portfolio return when the economy goes bust Rp = 0.5 × 8% + 0.25 × 4% + 0.25 × 0% = 5% The portfolio expected return: E(Rp) = 0.5 × 13.75% + 0.5 × 5% = 9.375%
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Unformatted text preview: The portfolio variance and the standard deviation You can also use the following method to calculate the portfolio expected return. Based on Assets Expected Returns on the individual stocks E(R A ) = 0.5 10% + 0.5 8% = 9% E(R B ) = 0.5 15% + 0.5 4% = 9.5% E(Rc) = 0.5 20% + 0.5 0% = 10% The portfolio expected return: E(Rp) = 0.5 9% + 0.25 9.5% + 0.25 10% = 9.375% 4.375% or 0.04375 .0019141 0.0019141 .09375) (.05 .50 .09375) (.1375 .50 p 2 2 2 p = = = + =...
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