Kelly Devilbiss - Problem 7-20 1

Problem 7-20
Texas lotto winner has decided to invest $50,000 a year
in the stock market.
Stocks for consideration are a petrochemical firm and a
public utility.
Risk index is assigned to each of the stocks:
Petrochemical = 9
Utility = 4
Maximize the return, but the average risk index should
not be higher than 6.
Estimated Returns:
Petrochemical = 12%
Utility = 6%
Kelly Devilbiss - Problem 7-20 2
Solve for:
1. How much should be invested for each
stock?
2. What is the average risk for this
investment?
3. What is the estimated return for this
investment?
Kelly Devilbiss - Problem 7-20 3
QM for Windows

P = Petrochemical / U = Utility
Maximize: Estimated % return for each stock
Total Investment: 1P + 1U = $50,000
Risk Index: 9P + 4U $300,000 because the average risk index
should not be higher than 6.
(9P + 4U)/$50,000 6 [$50,000 x 6 = $300,000]
Estimated Return: .12P + .06U $6,000
[$6,000 would be the maximum return possible]
Kelly Devilbiss - Problem 7-20 4
QM for Windows - Solve

How much should be invested in each stock?
Petrochemical = $20,000
Utility = $30,000
What is the estimated return for this investment?
$4,200
Kelly Devilbiss - Problem 7-20 5
Kelly Devilbiss - Problem 7-20 6
What is the average risk for this investment?
9P + 4U / $50,000 = average risk
9(20,000) + 4(30,000) / 50,000
= 180,000 + 120,000 / 50,000
= 300,000 / 50,000
= 6

Average risk = 6