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MMP321 – Topic 5 Seminar Solutions

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Topic 5: Portfolio theory and property securitization

Question 1:

Complete the following table for the four broad asset classes.

Asset class

Average return

(High, medium,

low etc.)

Liquidity

(High, medium,

low etc.)

Risk

(High, medium, low

etc.)

Cash

Very low

Very high

Very low

Bonds

Low

High

Low

Property

Moderate

Dependent on

structure*

Moderate

Shares

High

High

High

* Direct property investment is very illiquid, whilst securitized property

investment such as unlisted property trusts have higher liquidity. REITs have the

highest liquidity because they are listed on a securities exchange.

Question 2:

Using the information below, calculate the portfolio return.

Asset

Return

Weighting

A

12%

40%

B

9%

20%

C

15%

30%

D

13%

10%

SOLUTION:

Portfolio return = (12%)(0.4) + (9%)(0.2) + (15%)(0.3) + (13%)(0.1) = 12.4%

Question 3:

You have invested 35% of your wealth in asset X and 65% in asset Y. The average

return for X and Y is 10% and 14% respectively. The correlation coefficient is 0.6

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MMP321 – Topic 5 Seminar Solutions

and asset X has a standard deviation of 9.8%, while asset Y has a standard deviation

of 12.1%.

i) Calculate the expected return of the portfolio.

ii) Calculate the standard deviation of the portfolio.

SOLUTION:

Part i) Expected return on portfolio = (10%)(0.35) + (14%)(0.65) = 12.6%

Part ii) Portfolio standard deviation: (note: similar to calculating standard

deviation of a single asset, it is easier to input your values as decimals).

•

•

•

Question 4:

i) Download the file loaded in CloudDeakin titled “Topic 5 COR calculation

returns”. Using excel calculate the correlation coefficient for Brookfield

Prime Property Fund and Abacus Property Group.

ii) Why, when calculating the standard deviation of a portfolio, can’t we

simply estimate the weighted average of the standard deviation of the

individual assets?

SOLUTION:

Part i) In excel type (highlight cells) the following command:

CORREL(B2:B26,C2:C26)

Output should give you a correlation coefficient of 0.2492

Part ii) We need to consider the relationship between each asset. This is captured

by the correlation coefficient and is a measure of how two independent assets

move in relation to one another.

The correlation coefficient is bounded between -1 and +1.

-1 means the two assets move in opposite direction to each other. This results in

complete risk reduction.

+1 means the two assets move exactly the same and results in no risk reduction.

MMP321 – Topic 5 Seminar Solutions

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Question 5:

i) The diagram below displays the efficient frontier. Which portfolios are

efficient and which are inefficient?

ii) Why do we want our portfolios to sit on the efficient frontier?

SOLUTION:

Part i) Portfolios A and B are efficient because they sit on the efficient frontier

curve. Portfolio C and D are inefficient.

Part ii) Portfolios that sit on the efficient frontier provide us with the highest

possible return given a particular level of risk. Anything under the frontier gives

us a lower rate of return that we could achieve for the same level of risk if the

portfolio is on the efficient frontier.

Question 6:

Define the term ‘securitisation’ and give an example.

SOLUTION:

Securitisation is the issuing of securities backed by investment assets. An example

is when a property trusts purchases properties and sells units in the trust. The units

value is based on the market value of the underlying properties.

R

σ

A

C

D

B