While your financial consulting partnership has the most up to date software for, among other...

Question

While your financial consulting partnership has the most up to date software for, among other things, portfolio analysis, you feel it would be of benefit to have Joan learn and demonstrate calculations specific to portfolio management. So that she can practice preparing actual high quality consulting reports, you give Joan the following assignment to prepare, in a “White Paper” format.

This paper will serve to not only demonstrate her knowledge of portfolio management which she can use with individual investors, but will also demonstrate to corporate CFO’s the issues they need to be concerned about if the CFO’s wish investors to be interested in adding their firms stock to their existing portfolios.

The White Paper should address the following

In your own words, describe what portfolio management and the benefits of portfolio diversification are.
- Your answer must include words likevariability of returns,portfolio standard deviation, andnegative correlation of returns.
Given the following information about two different stocks, calculate the average return and standard deviation of returns.Show all work.

Stock A
Stock B
Year
% return
% return
2005
15
15
2006
-5
35
2007
35
-5
2008
-10
40
2009
40
-10
Average Return
Standard Deviation

Show expected return each year for a portfolio made up of 50% stock A, and 50% stock B.

Stock A
Stock B
Portfolio
Year
% return
% return
% return
2005
15
15
2006
-5
35
2007
35
-5
2008
-10
40
2009
40
-10
Average Return
Standard Deviation

Based on your 2 calculations, what conclusions can you reach about risk and return when buying an individual stock, and when creating a portfolio?
Explain what the CAPM is all about in terms of expected return on an individual stock and how a firm seeking to raise money by issuing new common stock would be concerned with the Beta of its common stock.

Robert · Accepted Answer

Portfolio Management 
For an investor, investing in just one stock is not advisable due to many reasons. The 
most important being the inherent risk that is there in a single investment. Hence, there is a need 
for the investors to create an investment mix depending o the risk he or she can take and the 
expected return needed from the market. This is done though the creation of portfolio by the 
investors. 
Portfolio management is nothing but the creating of that optimal investment mix to get 
the desired return given the amount of risk a person can take. The returns in the market from any 
asset class are not stable and there is a huge variability in the returns. Because of that, there is a 
need to research on the stocks and other asset classes that can reduce this risk. 
Risk is measured in standard deviation of the portfolio and this can be reduced by adding 
asset classes that have less or negative correlation with respect to each other. Correlation means 
when returns of one asset class decreases, what is the effect of the same on other asset class. 
When returns are negatively correlated, if one asset class gives negative return another asset will 
give positive return and hence the investments are somewhat safe for the investor.

While your financial consulting partnership has the most up to date software for, among other things, portfolio analysis, you feel it would be of benefit to have Joan learn and demonstrate...

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Stock A	Stock B
Year	% return	% return
2005	15	15
2006	-5	35
2007	35	-5
2008	-10	40
2009	40	-10
Average Return
Standard Deviation

Stock A	Stock B	Portfolio
Year	% return	% return	% return
2005	15	15
2006	-5	35
2007	35	-5
2008	-10	40
2009	40	-10
Average Return
Standard Deviation