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Quiz 1
Quiz 1
Quiz 1
QUIZ 1
Additional Materials: -
Apparatus Allowed: Scientific/Financial Calculators
INSTRUCTIONS TO CANDIDATES
1. This paper consists of 5 questions and students are to answer ALL questions.
2. Read the above information carefully to ensure you have the correct and complete
question paper.
3. Please write down your answer in the space provided in the question paper.
4. Candidates are not allowed to start the exam room except during the stipulated time frame
given.
5. Candidates are required to email the answer with question paper via email to
annuar.nassir@xmu.edu.my and to identify the file name based on their student ID 10
minutes after the quiz is over. Failure to do so will result in a deduction of 5 marks from
the total score.
1. How do you construct a portfolio with the highest Sharpe ratio? Explain briefly selecting
undervalued or underpriced asset in a portfolio will increase the Sharpe ratio. Illustrate with
an example.
(1.5 marks)
Answer:
2. Define what is an efficient frontier according to Modern Portfolio Theory. How does
Modern Portfolio Theory assist us in Portfolio Management?
(1.5 marks)
Answer:
3. Stock A has an expected return of 8% and a standard deviation of 40%. Stock B has an
expected return of 13% and standard deviation of 60%. The correlation between A and B is
negative one. Show that you can form a zero risk portfolio and show also the zero risk
portfolio is also the minimum variance portfolio using an appropriate example.
(1.5 marks)
Answer:
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4. The following diagram shows the investment opportunity set for portfolios containing
stocks A and B. You need to know that:
Point A on the graph represents a portfolio with 100% in stock A
Point B represents a portfolio with 100% in stock B
9.00%
8.00%
A
z
7.00% y
x
Portfolio Expected Return
6.00%
w
5.00%
4.00% B
3.00%
2.00%
1.00%
0.00%
0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00%
Portfolio Standard Deviation
a. Is the correlation between A and B greater than, equal to, or less than +1. Support your
argument by estimating the correlation coefficient.
b. Which labeled point on the graph represents the minimum variance portfolio? Based on
the correlation estimated in (a), determine the weights of A and B in the minimum
variance portfolio. What are the minimum variance portfolio return and standard
deviation?
c. Which labeled point on the graph represents a portfolio with 88% invested in stock A and
the rest in B and a portfolio with 75% invested in B and the rest in A?
d. If A and B are the only investments available to an investor, which of the labeled
portfolios are efficient?
e. Suppose a risk-free asset exists, allowing an investor to invest or borrow at the risk-free
rate of 3%. If the above graph is drawn perfectly to scale, determine the optimal portfolio
return and standard deviation and which labeled point represents the optimal risky
portfolio.
f. Under the assumptions in part (e), would it be wise for an investor to invest all of his or
her money in stock A? Why or why not?
g. Briefly explain few portfolio principles learned on the above analysis (a to f) and how it
can be applied in Portfolio Management.
(5 marks)
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Answer:
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5a. Describe how an investor may combine a risk-free asset and one risky asset in order to
obtain the optimal portfolio for that investor. Provide with an example. (1 mark)
Answer
b. Theoretically, the standard deviation of a portfolio can be reduced to what level? Explain.
Realistically, is it possible to reduce the standard deviation to this level? Illustrate with an
example.
(1 marks)
Answer
c. Under what condition will adding a security with a high standard deviation decrease the risk
of a portfolio? Illustrate with an example. (1 mark)
Answer:
- END OF QUESTION –
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Formula sheet
2 2
1. AR = (R)/n; = [(R -R ) ]/n-1
t A
2 2
2. E(R) = P R ; = P *[R -E(R)]
i i i i
3. Cov =[R - E(R )]*[R - E(R )]/n-1
ij i,t i j,t j
R1 – Rf = Z1Z2
R2 – Rf = Z1Z2
R3 – Rf = Z1Z2
W =Z /
i i Zi
11. CML: R = R + (R – R )/ *
p f m f m p
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