Ch. 6 EOC Assignment
For any problems that require use of data in Excel, simply write down the ultimate answer on the paper
that you turn in (you don’t need to show your work on the paper that was performed in Excel).
Spreadsheets 6.1 and 6.2
6. Suppose that the returns on the stock fund presented
in Spreadsheet 6.1 were −40%, −14%, 17%, and 33% in the
four scenarios. (LO 6-2)
a. Would you expect the mean return and variance of the stock fund
to be more than, less than, or equal to the values computed
in Spreadsheet 6.2? Why?
.
Calculate the new values of mean return and variance for the stock
fund using a format similar to Spreadsheet 6.2. Confirm your
intuition from part (a).
c. Calculate the new value of the covariance between the stock and
ond funds using a format similar to Spreadsheet 6.4. Explain
intuitively the change in the covariance.
The following data apply to Problems 8–12.
A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-
term government and corporate bond fund, and the third is a T-bill money market fund that yields a sure
ate of 5.5%. The probability distributions of the risky funds are:
The co
elation between the fund returns is .15.
8. Tabulate and draw the investment opportunity set of the two
isky funds. Use investment proportions for the stock fund of
0% to 100% in increments of 20%. What expected return and
standard deviation does your graph show for the minimum-
variance portfolio? (LO 6-2)
9. Draw a tangent from the risk-free rate to the opportunity set.
What does your graph show for the expected return and
standard deviation of the optimal risky portfolio? (LO 6-3)
10. What is the Sharpe ratio of the best feasible CAL? (LO 6-3)
11. Suppose now that your portfolio must yield an expected return
of 12% and be efficient, that is, on the best feasible CAL. (LO
6-4)
a. What is the standard deviation of your portfolio?
. What is the proportion invested in the T-bill fund and each of the
two risky funds?
12. If you were to use only the two risky funds and still require an
expected return of 12%, what would be the investment
proportions of your portfolio? Compare its standard deviation
to that of the optimal portfolio in the previous problem. What do
you conclude? (LO 6-4)
21. The following figure shows plots of monthly rates of return and
the stock market for two stocks. (LO 6-5)
a. Which stock is riskier to an investor cu
ently holding a
diversified portfolio of common stock?
. Which stock is riskier to an undiversified investor who puts all of
his funds in only one of these stocks?
2. George Stephenson's cu
ent portfolio of $2 million is invested as
follows:
Stephenson soon expects to receive an additional $2 million and plans
to invest the entire amount in an index fund that best complements the
cu
ent portfolio. Stephanie Coppa, CFA, is evaluating the four index
funds shown in the following table for their ability to produce a portfolio
that will meet two criteria relative to the cu
ent portfolio: (1) maintain or
enhance expected return and (2) maintain or reduce volatility.
Each fund is invested in an asset class that is not substantially
epresented in the cu
ent portfolio.
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State which fund Coppa should recommend to Stephenson. Justify your
choice by describing how your chosen fund best meets both of
Stephenson's criteria. No calculations are required. (LO 6-4)
3. Abigail Grace has a $900,000 fully diversified portfolio. She
subsequently inherits ABC Company common stock worth $100,000.
Her financial adviser provided her with the following estimates: (LO 6-5)
The co
elation coefficient of ABC stock returns with the original
portfolio returns is .40.
a. The inheritance changes Grace's overall portfolio and she is deciding
whether to keep the ABC stock. Assuming Grace keeps the ABC stock,
calculate the:
i. Expected return of her new portfolio which includes the ABC stock.
ii. Covariance of ABC stock returns with the original portfolio returns.
iii. Standard deviation of her new portfolio which includes the ABC stock.
. If Grace sells the ABC stock, she will invest the proceeds in risk-free
government securities yielding .42% monthly. Assuming Grace sells the
ABC stock and replaces it with the government securities, calculate the:
i. Expected return of her new portfolio which includes the government
securities.
ii. Covariance of the government security returns with the original
portfolio returns.
iii. Standard deviation of her new portfolio which includes the government
securities.
c. Determine whether the beta of her new portfolio, which includes the
government securities, will be higher or lower than the beta of her original
portfolio.
d. Based on conversations with her husband, Grace is considering selling the
$100,000 of ABC stock and acquiring $100,000 of XYZ Company
common stock instead. XYZ stock has the same expected return and
standard deviation as ABC stock. Her husband comments, “It doesn't
matter whether you keep all of the ABC stock or replace it with $100,000
of XYZ stock.” State whether her husband's comment is co
ect or
inco
ect. Justify your response.
e. In a recent discussion with her financial adviser, Grace commented, “If I
just don't lose money in my portfolio, I will be satisfied.” She went on to
say, “I am more afraid of losing money than I am concerned about
achieving high returns.” Describe one weakness of using standard deviation
of returns as a risk measure for Grace.
7. Dudley Trudy, CFA, recently met with one of his clients. Trudy
typically invests in a master list of 30 equities drawn from
several industries. As the meeting concluded, the client made
the following statement: “I trust your stock-picking ability and
elieve that you should invest my funds in your five best ideas.
Why invest in 30 companies when you obviously have stronger
opinions on a few of them?” Trudy plans to respond to his client
within the context of Modern Portfolio Theory. (LO 6-1)
a. Contrast the concepts of systematic risk and firm-specific risk, and
give an example of each type of risk.
. Critique the client's suggestion. Discuss how both systematic and
firm-specific risk change as the number of securities in a portfolio
is increased.