Risk Return Analysis

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University of Toronto Scarborough

MGTB09H3PrinciplesofFinance Winter2010 Additionalselfstudyexercisestopic6RiskReturnAnalysis answersattheend Questions Question 1 (Risk and Return) Given the following information on a portfolio of 3 stocks held by Asif Thakor: State of Mei Wa Rate Man-Lei Rate Masair Rate Economy Probability of Return of Return of Return Boom 0.35 0.30 0.45 1.35 Normal 0.40 0.20 0.25 0.45 Bust 0.25 0.00 -0.35 -0.95 a. If Asifs portfolio is invested 30% in Mei Wa, 50% in Man-Lei, and 20% in Masair, what is the portfolio expected return? The variance? The standard deviation? b. If the expected T-Bill rate is 5%, what is the expected risk premium on the portfolio? c. If the expected inflation rate is 2%, what is the expected real return on the portfolio? What is the expected real risk premium on the portfolio? d. What is the required rate of return on the portfolio, if the market risk premium is 7%, and portfolio beta is 1.6? Question 2 (Risk and Return) Following is the historical cash dividend and price data on Aaron Kam & Yeon Kim Systems (AYS) and Nhi La & Eric Leung Enterprises (NEE) stocks: Aaron Kam & Yeon Kim Systems Nhi La & Eric Leung Enterprises Cash Yr. end Cash Yr. end Year Dividend Price Year Dividend Price 1993 $--- $40.00 1993 $--- $15.00 1994 2.00 43.00 1994 --- 22.00 1995 2.50 38.50 1995 0.50 18.50 1996 2.50 48.00 1996 0.50 14.00 1997 3.00 44.00 1997 0.50 28.50 a. Calculate the yearly rate of returns for AYS and NEE stocks, and a portfolio comprised of 40% invested in AYS stock and 60% invested in NEE stock. b. Calculate the mean rate of returns and standard deviations for AYS stock, NEE stock and the portfolio. Suppose the risk free rate is 4%. Calculate the Sharpe ratios of both stocks and that of the portfolio. What is your conclusion based on these Sharpe ratios? 1 www.notesolution.com
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