BAC 3684 Tutorial Chapter 7 & 8

End of Chapter Questions

7-1 Distinguish between historical return and expected return.
- Historical returns are realized returns, or ex-post returns.
- Expected returns are ex-ante returns. They are the most likely returns for the future,
although they may not actually be realized because of risk.
7-2 How is expected return for one security determined? For a portfolio?
- The expected return for one security is determined from a probability distribution
consisting of the likely outcomes and their associated probabilities, for the security.
- The expected return for a portfolio is calculated as a weighted average of the
individual securities’ expected returns. The weights used are the percentage of total
investable funds invested in each security.
7-3 Given the large-cap stock index and the government bond index data in the following
table,
calculate the expected mean return and standard deviation of return for a portfolio 75 percent
invested in the stock index and 25 percent invested in the bond index.
MCQ Questions
1. A portfolio manager creates the following portfolio:

If the correlation of returns between the two securities is 0.40, the expected standard
deviation of the portfolio is closest to:
A. 10.7%.
B. 11.3%.
C. 12.1%.

2. A portfolio manager creates the following portfolio:

If the covariance of returns between the two securities is -.0240, the expected standard
deviation of the portfolio is closest to:
A. 2.4%.
B. 7.5%.
C. 9.2%.

Problem Questions
7-1 Calculate the expected return and risk (standard deviation) for General Foods given the
following information:
Probabilities Expected Returns
0.10 0.20
0.20 0.16
0.40 0.12
0.15 0.05
0.15 -0.05

(0.10)(0.2) = 0.20
(0.2)(0.16) = 0.032
(0.4)(0.12) = 0.048
(0.15)(0.05) = 0.0075
(0.15)(-0.05) = -0.0075
Expected return = 0.10 or 10%
To calculate the standard deviation for General Foods, use the formula:
7-2 Four securities have the following expected returns:
A =12%, B=15%, C =22%, and D = 30%
Calculate the expected returns for a portfolio consisting of all four securities under the
following conditions:
a. The portfolio weights are 25 percent each.
b. The portfolio weights are 10 percent in A, with the remainder equally divided among the
other three stocks.
c. The portfolio weights are 20 percent each in A and B, and 30 percent each in C and D

7-3 Assume the additional information provided below for the four stocks in Problem 7-2.

a. Assuming equal weights for each stock, what are the standard deviations for the following
portfolios?
A, B, and C
B and C
B and D
C and D
b. Calculate the standard deviation for a portfolio consisting of stocks B and C, assuming the
following weights: (1) 30 percent in B and 70 percent in C; (2) 70 percent in B and 30
percent in C.
c. In part a, which portfolio(s) would an investor prefer?