Assignment 2

The following table of compound annual returns by decade applies to problem 1 to 2

Q1: input the data from the table into a spread sheet. Compute the serial correlation in
decade returns for each asset class and for inflation. Also find the correlation between
the returns of various asset classes. What do the data indicate?

Q2: Convert the asset returns by decade presented in the table into real rates. Repeat
problem 1 for the real rates of return.

Visit professor Kenneth French’s data library website:

http://mba.tuck.darmouth.edu/pages/faculty/ken.french/data_library.html and
download the monthly return of “6 portfolios formed on size and book to market (2 x
3).” choose the value weighted series for the period from january 1930 december
2018. split the sample in half and compute the average, SD, skew, and kurtosis for
each of the six portfolios for the two halves. Do the six split halves statistics suggest
to you that return come from the same distribution over the entire period?

Q3: During a period of severe inflation, a bond offered a nominal HPR of 80% per
year. The inflation rate was 70% per year.

a. What was the real HPR on the bond over the year?
b. Compare this real HPR to the approximation rreal ≈ rnom - I.

Q4: Suppose that the inflation rate is expected to be 3% in the near future. Using the
historical data provided in this chapter, what would be your prediction for:

a. The T-bill rate?

b. The expected rate of return on the Big/Value portfolio?
c. The risk premium on the stock market?

Q5: Consider a portfolio that offers an expected return-standard deviation of 18%. T-

Bills offer a risky-free 7% rate of return. What is the maximum level of risk aversion
for which the risky portfolio is still preferred to T-Bill.
Assignment 2

Q6: Suppose that your risky portfolio includes the following investments in the given
propositions:
Stock A 25%
Stock B 32%
Stock C 43%
What are the investments propositions of your client’s overall portfolio, including the
position in T-bills?

Q7: Your Client’s degree of risk aversion is A=3.5.

a. What proposition, y, of the total investment should be invested in your funds?
b. What are the expected value and standard deviation of the rate of return on your
client’s optimized portfolio?

Q8. Why do we call alpha a NONMARKET return premium? Why are the high alpha
stocks desirable investments for active portfolio managers? With all other parameters
held fixed, what would happened to a portfolio’s Sharpe ratio as the alpha of its
component securities increased?

Q.9 A portfolio management organization analyzes 60 stock and constructs a mean -

variance efficient portfolio using only these 60 securities.
A. How many estimates of expected return, variances, and covariance are needed to
optimize this portfolio?
B. if one could safely assume that stock market returns closely resemble a single
index structure, how many estimates would be needed?