P5.3 Assume you are considering a portfolio containing two assets, Land M.

Asset L will represent

40% of the dollar value of the portfolio, and asset M will account for the other 60%. The
expected returns over the next 6 years, 2009-2014, for each of these assets are summarized in
the following table.

Expected Return (%)

Year Asset L Asset M
2009 14 20
2010 14 18
2011 16 16
2012 17 14
2013 17 12
2014
19 10

a. Calculate the expected portfolio return, rp, for each of the 6 years.
2009 (.40*14% + .60*20%) = 17.6%
2010 (.40*14% + .60*18%) =16.4%
2011 (.40*16% + .60*16%) =16%
2012 (.40*17% + .60*14%) =15.2%
2013 (.40*17% + .60*12%) =14%
2014 (.40*19% + .60*10%) =13.6%

b. Calculate the average expected portfolio return, rp, over the 6-year period.
17.6 +16.4 +16 +15.2 +14 +13.6
6 =15.467%
c.
Calculate the standard deviation of expected portfolio returns, sp over the 6- year period.

Sp= 1.6- -15.47) +(16.4-15.47) +(16-15.47) +(15.2-15.47) +(14-15.47) +(13.6-15.4

2 2 2 2 2

J =1.51%
6- 1

d. How would you characterize the correlation of returns of the two assets L
and M?
Portfolio LM illustrates negative correlation because these two return stream behave in opposite
fashion over the 6 years period.

e. Discuss any benefits of diversification achieved through creation of the portfolio.

To reduce overall risk in a portfolio. It is best to combine assets that have negative or low
positive correlation. Which means when any assets didn’t perform well in some period, the other
assets that perform well can cover the losses.

This study source was downloaded by 100000872122596 from CourseHero.com on 09-23-2023 07:59:55 GMT -
05:00

https://www.coursehero.com/file/15819896/Tutorial-5/
 P5.9 Mark
Year et A B
2001 -13% -4% -10%
2003 -8% 0% -3%
2002 -4% 3% 3%
2000 2% 8% 11%
1999 6% 11% 16%
2007 8% 12% 19%
2005 10% 14% 22%
2008 13% 17% 26%
2006 15% 18% 29%
2004 16% 19% 30%

a)

Chart Title

b) beta equal to gradient of the trend line

B: 0=1.3787
A: 0=0.7907
c) Investment A has higher beta than investment B. This shows that Investment A’s return is more
responsive to changing of market returns. Therefore, investment A is more risky than investment B.

P5.10

This study source was downloaded by 100000872122596 from CourseHero.com on 09-23-2023 07:59:55 GMT -
05:00

https://www.coursehero.com/file/15819896/Tutorial-5/
 You are evaluating 2 possible stock investments, Buyme Co. and
Getit Corp. Buyme Co. has an expected return of 14%, and a beta
of 1. Getit Corp. has an expected return of 14%, and a beta of 1.2.
Based only on this data, which stock should you buy and why?

Since both investment having the same expected return, so the only difference is the
beta.
I will choose the investment which consist of beta 1.0 since it is lower risk compare to
the beta 1.2 due to the investment return of beta 1.2 will change more dramatically
compare to beta 1.0 (Buyme.co),
However, if you are a risk seeker beta 1.2 will be a better choice since it is high risk
along with higher return

P5.12
A security has a beta of 1.20. Is this security more or less risky than the market?
Explain. Assess the impact on the required return of this security in each of the
following cases.
a. The market return increases by 15%.
b. The market return decreases by 8%.
c. The market return remains unchanged.

Security with beta 1.20 is risky than market since its return change 20% more
than the market rate of change.
a. The security return increase by 18% (1.2(15%))
b. The security return decrease by 9.6% (1.2 (-8%))
c. The security return remain unchanged (0% x 1.2 = 0%)
The asset is more risky than mkt p/f, which has a beta of 1.
P5.13 change in security return = beta *change in market return
a. Security A: Change in return = 13.2% x 1.40
= 18.48 %

This study source was downloaded by 100000872122596 from CourseHero.com on 09-23-2023 07:59:55 GMT -
05:00

https://www.coursehero.com/file/15819896/Tutorial-5/
 Security B: Change in return = 13.2% x 0.80
= 10.56 % Security C: Change in return = 13.2% x -0.90 = -11.88 %
b. Security A: Change in return = -10.8% x 1.40
= -15.12 %

Security B: Change in return = -10.8% x 0.80

= - 8.64 %
Security C: Change in return = -10.8% x -0.90
= 9.72 %
c. Security A with Beta 1.40 has a strong, positive relation with the market and riskier than the market.
Which it follows the market’s trend and most responsive compare to Security B and C. For example,
if the market has an increase or decrease, Security A follows the same direction and in greater
amplitude (highest relevant risk). Security B with Beta 0.80 has a weak, positive relation with the
market and lesser risky than the market. It follows the market’s trend but in lesser amplitude and less
responsive.
Security C with Beta -0.90 has a negative relation with the market. Which means if the market has an
increasing trend, it will has an opposite direction (decrease) and vice versa.
Thus, when the economic goes into a downturn, Security C might perform the best among the other
securities, as it has a negative relation with the market. It will have an increase when the market has
an downturn.
Learning Outcome: Calculate portfolio betas
P5.23 Rose Berry is attempting to evaluate 2 possible portfolios consisting of the same 5 asset but held
in different proportions. She is particularly interested in using beta to compare the risk of the
portfolios and, in this regard, has gathered the following data:

Portfolio Weights (%)

Asset Asset Beta Portfolio A Portfolio B
1 1.30 10 3
2 0.70 30 1
3 1.25 10 2
4 1.10 10 0 2
5 0.90 40 2
Total 100 1

a. Calculate the betas for portfolios A and B.

n

p= Z w,P,
i=1

P
of portfolio A = 0.10(1.30) + 0.30(0.70) + 0.10(1.25) +0.10(1.10) + 0.40(0.70)
= 0.935

This study source was downloaded by 100000872122596 from CourseHero.com on 09-23-2023 07:59:55 GMT -
05:00

https://www.coursehero.com/file/15819896/Tutorial-5/
 P
of portfolio B = 0.30(1.30) + 0.10(0.70) + 0.20(1.25) +0.20(1.10) + 0.20(0.70)
= 1.110

b. Compare the risk of each portfolio to the market as well as to each other. Which portfolio is
more risky?

Portfolio A has a beta of 0.935, which is lower than the market beta 1.0, therefore it is less risky
than the overall market.

Portfolio B has a beta of 1.110, which is higher than the market beta 1.0, therefore it is more
risky than the overall market.

Portfolio B is more risky than Portfolio A since it has a higher beta.

This study source was downloaded by 100000872122596 from CourseHero.com on 09-23-2023 07:59:55 GMT -
05:00

https://www.coursehero.com/file/15819896/Tutorial-5/