Answers to End of Chapter 7 Problems

Introduction to Risk and Return

10. a.

The real return on the stock market in each year was:

1929:
1930:
1931:
1932:
1933:

-14.7%
-23.7%
-38.0%
0.5%
56.5%

b. The average real return was: -3.89%

c.

The risk premium for each year was:

1929:
1930:
1931:
1932:
1933:

14.

15.

-19.3%
-30.7%
-45.0%
-10.9%
57.0%

d.

The average risk premium was: 9.78%

e.

The standard deviation () of the risk premium

a.

b.

c.

a.

p2

p2
p2

= 0 . 0196
= 0 . 0148
= 0 . 0100

No. of variance terms = 100

No. of Covariance terms = 1002 100 = 9,900

b.

2 =0.03708
= 0.193 = 19.3%

c.

= 0.190 = 19.0%

=
39.46%

16.

a.
(Part a)
No. of
Shares
1
2
3
4
5
6
7
8
9
10
b.
c.

Underlying market risk = 0.048

No. of
Shares
1
2
3
4
5
6
7
8
9
10

17.

Variance
.160000
.104000
.085333
.076000
.070400
.066667
.064000
.062000
.060444
.059200

(Part a)
Standard
Deviation
.400
.322
.292
.276
.265
.258
.253
.249
.246
.243

Variance
.160000
.080000
.053333
.040000
.032000
.026667
.022857
.020000
.017778
.016000

Standard
Deviation
.400
.283
.231
.200
.179
.163
.151
.141
.133
.126

Portfolio variance = 0.036643555

18. The safest attainable portfolio is comprised of Canadian Pacific and Nestle.
BP
Deutsche
Fiat
Heineken
LVMH
Nestle
Tata

Variance
0.0316
0.0506
0.0594
0.0320
0.0335
0.0233
0.0811

19.
a.
If the market rises by an extra 5%, the expected change in the stocks rate
of return is 1.25%. If the market declines an extra 5%, then the expected change is
+1.25%.
b.
20.

The largest reduction in beta is achieved by investing the $20,000 in a

stock with a negative beta. Option (iii) is correct.

Portfolio Weights: xA = 0.60 and xB = 1 xA = 0.40

Portfolio variance = 592
Standard deviation =

21.

a.

= 592=24 . 33%

Portfolio variance: P2 = 395.942

Standard deviation = P = 19.88%

b.

P2 = 175.574
P = 13.25%

c.

Standard deviation = 2 19.88% = 39.76%

d.

For stocks like Dell, P = 1.41 15% = 21.15%

For stocks like McDonalds, P = 0.77 15% = 11.55%

22.

Portfolio

X1

X2

1
2
3
4
5
6

1.0
0.8
0.6
0.4
0.2
0.0

0.0
0.2
0.4
0.6
0.8
1.0

23.
Beta
BP

0.45132541

Canadian

0.70116280

Deutsche

1.36232197

Fiat

1.52191316

Heineken

0.79502920

LVMH

0.89156306

Nestle

0.48880485

Tata

1.78787955

Expected
Return
0.060
0.077
0.094
0.111
0.128
0.145

Standard
Deviation
0.000
0.040
0.080
0.120
0.160
0.200