The risk-return relationship will now be measured in terms of the portfolio’s expected return and the portfolio… 0000038699 00000 n Risk and Return: Portfolio Theory and Asset Pricing Models ANSWERS TO END-OF-CHAPTER QUESTIONS Question: RISK AND RETURN You Own A Portfolio Consisting Of The Following Stocks. The portfolio risk is not simply a measure of its weighted average risk. The concepts of systematic and unsystematic risk are introduced here. 0000004694 00000 n (That is, required returns equal expected returns.) 0000003948 00000 n Open the spreadsheet and perform the required analysis to answer the questions below. c. %PDF-1.3 stream The securities consisting in a portfolio are associated with each other. the same portfolio of risky securities is a result of: (a) diminishing marginal utility of income (b) covariance (c) the separation theorem (d) the normal distribution assumption 3. Expected return = 0.4(0.05) + 0.6(0.15) = 0.02 + 0.09 = 0.11 or 11% %%EOF 0000010277 00000 n ... Let us now assume investments can be combined into a two-asset portfolio. Determine return of portfolio if first security constitutes 40% of total portfolio. 0000003870 00000 n RISK AND RETURN This chapter explores the relationship between risk and return inherent in investing in securities, especially stocks. 0000002905 00000 n 0000003333 00000 n Describe the CAPM and explain what it does. xref CHAPTER 1 Exercise 1.1. In what follows we’ll define risk and return precisely, investi-gate the nature of their relationship, and find that there are ways to limit exposure to in-vestment risk. portfolioZwith expected return 9%, standard deviation 21% X dominates Z; it has higher reward but lower risk (III) An investor using the Mean-Variation Criterion: b. may concentrate all investments in Security B (IV) John and Jim are both risk averse and only care about the mean and standard deviation of their portfolio’s return. Visit the post for more. 4 0 obj Our final step would be the plot of the risk and return combined metric, return per unit of risk, which plots the portfolio risk and return for different values of portfolio allocation. 0000001869 00000 n 0000008875 00000 n 0 answers you are looking at involve the examiner having algebraically-rearranged the formulae found on this sheet. methods of investment analysis and portfolio formation, stocks and bonds analysis and valuation for investment decision making, options pricing and using as investments, asset allocation, portfolio rebalancing, and portfolio performance measures. 0000002372 00000 n 0000006738 00000 n Open spreadsheet. ���s��6?Y��V#P9l`�'��R؃K�ӽ�N��_�RV*�yU���[���\��C�X��9�Ɂ�KzN�ْ�P�+��YJ����� � �V"�P�uw��0l0 Some of the risk in holding any asset is unique to the asset in question. 0000008829 00000 n book Risk and Portfolio Analysis: principles and methods is not yet fully complete. Risk and Return Discussion/Practice Problems … The risk premium of an asset is proportional to its beta. Illustration 16.2: Compute the risk return characteristic of an equally weighted portfolio of three securities whose individual risk and return are given in the following table. Portfolio risk is what matters to investors and portfolio risk is what governs the risk premiums they demand. This result occurs because returns on A and B are not perfectly positively correlated (ρAB = 0.88). 5. 8. ∴ Portfolio return is 12.98%. 2. Explain Markowitz Portfolio Theory? Mean portfolio return 12% Var(P) 0.00845 sd(P) 9.2% • The risk of the portfolio is lower than the risk of either of the two stocks! Questions and Answers ... CFA, is an analyst with a large money management firm. Answer. If the portfolio is comprise of 40% X and 60% Y and if the correlation between the returns on X and Y is -0.25, what is the portfolio’s expected return and risk? 0000007457 00000 n 0000003621 00000 n Individual ... it complicates the task of constructing portfolios with ‘efficient’ risk return trade-off due to the growth of possible asset combinations. Also The Expected Return On The Market Portfolio Is 15 Percent. portfolio components, so there is no enhancement of portfolio return. View Test Prep - Risk and Return Practice Problems with Solutions.pdf from BA D1 at Brenau University. 0000002012 00000 n 0000012948 00000 n <<9677f80f1c0983448a384dbcca936b1d>]>> The rate of return on the annuity is the same as the rate of return on US T-Bills. Questions have also been Question: (Graphical representation systematic and unsystematic risk) In the examiners ‘Questions and Answers’ for May 2010, question four (a) required a diagram illustration for systematic and unsystematic risks. 0000006050 00000 n �����]�y�*n~/M�Ev�3��X�`������І�Av��j���������V3t�8e�[�K6���e`6lˠ�Ao҈��9�*z�gzN����Uhi��� It is of little use to investors who wish to earn large returns. {\G����M�ѕ�y�C. 0000007867 00000 n Risk and Return Problems and Solutions is set of questions and answers for risk and expected return and its associated cash flows. endstream endobj 1443 0 obj<>/W[1 1 1]/Type/XRef/Index[56 1361]>>stream x���1 0ð4\ 0000001213 00000 n The expected return – beta relationship is the implication of the CAPM that security risk premiums (expected excess returns) will … A risk-averse investor would choose the portfolio over either Stock A or Stock B alone, since the portfolio offers the same expected return but with less risk. 0000000873 00000 n b. trailer 10 Key Points To Remember. 0000003371 00000 n Portfolio return is 12.98%. First we turn our attention to the concept of expected return. The data has been collected in the Microsoft Excel Online file below. If markets are efficient, the price reflects 0000001420 00000 n sponding suggested answers. The risk-free rate is 5.5%, and the market is in equilibrium. The beta is a relative measure of systematic risk. 0000008097 00000 n %��������� 1417 0 obj <> endobj 1420 0 obj<>stream 0000000016 00000 n What is the market risk premium (r M - r RF)? By investing in a variety of assets, this unique portion of the total risk can be eliminated at little cost. 0000005336 00000 n The securities consisting in a portfolio are associated with each other. a. Risk and return questions and practice problems Risk and return part 2: Questions 1. Portfolio risk and return Prepared by Pamela Peterson Drake, Ph.D., CFA 1. a. total return … total risk b. expected return … total risk c. total return … systematic risk d. expected return … systematic risk 13. Risk on Portfolio: The risk of a security is measured in terms of variance or standard deviation of its returns. You will get 30 minutes to complete the test. 0000009547 00000 n %PDF-1.5 %���� He also derived a formula for computing the variance/SD of a portfolio. Susan is expecting the returns on the market portfolio to be negative in the near term. Risk of Portfolio of Two Assets: The risk of a security is measured in terms of variance or standard deviation of its returns. The weight attached to an asset = market value of asset/market value of portfolio. The price We will suggest, as did H. Harkowitz in 1952, that the standard deviation of portfolio returns be used as a measure of total portfolio risk. • Markowitz showed that the variance of the rate of return was a meaningful measure of portfolio risk under a reasonable set of assumptions. i) Tax risk j) Etc 4. the concept of portfolio risk. On the other hand, there are some risks that affect all investments. startxref • The expected return on a portfolio is given by the weighted average returns of the two assets RP =XARA +XBRB • The variance of returns of a portfolio is given by σP XAσA XBσB 2XAXBσAB 2 = 2 2 + 2 2 + 3. Probability Possible rate of return 0.25 0.09 Following are the probability distribution of returns of portfolio of Stock A and Stock B in equal proportion of weight in each state of economy. Please inform us if you spot any errors. Portfolio expected return is the sum of each of the individual asset’s expected return multiplied by its associated weight. Once we have risk and return for individual securities, we can then calculate portfolio risk and return. There are 20 questions in this test from the Portfolio Management section of the CFA Level 1 syllabus. The portfolio return r p = 0.079 with the risk σ p = 0. Within the framework of modern portfolio theory, if portfolios A and B have the same return but portfolio A has less risk, then: The portfolio risk is not simply a measure of its weighted average risk. a) 12.4% b) 13.4% c) 14.4% d) 15.4% View Answer / Hide Answer CHAPTER 11 RISK AND RETURN: THE CAPITAL ASSET PRICING MODEL (CAPM) Answers to Concept Questions 1. The returns and the risk of the portfolio depending on the returns and risks of the individual stocks and their corresponding shares in the portfolio. A portfolio comprises two securities and the expected return on them is 12% and 16% respectively. Overview Security analysts and portfolio managers are concerned about an investment’s return, its risk, and whether it is priced correctly by the market. Portfolio risk is increasingly dependent on the covariance of returns. The above can be checked with the capital weightage formulas for the minimum variance (risk).Substituting Example 1. The possible rate of return for a portfolio for an investment is shown below. Stock Percentage Of Portfolio (%) Beta Expected Return (%) A 20 1 15 B 30 0.85 13 C 50 1.20 10 The Risk Free Is 6 Percent. Expected returns Portfolio risk Portfolio 1 23.20% 9.9% Portfolio 2 19.20% 10.0%. • Summaries, Key-terms, Questions and problems are provided at the end of 0000001558 00000 n Find the portfolio return and risk Answer. x�]K��Ƒ��W�e#�A�G��lP��� ɢ�q�`� �Cr�yP����_�?�_�_f�Q]��e#��*__=P����~s}���ڵ��?�O�pqw9�?7�닋�U����۽|1�����}yn�����w$���Oϊ�W�����������/�m�L!��Y1�����]����b��7u]�]�5�[�M���}��]�mM\[�UuL�+��s!��������ҭ_B/t�dl��zO��-ݡߠ�έ�Tݠ����4pqO��5���W=���+�GkW���+w�7e��v�r����� ��Uy�>���ZE'©�)5�U}�5M��������׿ʟW����g�8~�n����I ��T�b4V]�hl����\��CD|��ݻ@������D���{'���O!�n>�DZ�)��$�[wu��$N�"2ؙ,SH���Dc��՝��U������ �����mU�Mӷ4L�^��?�����:L�oߺ�W��!g\����;�r���&:�weU�j�1��.��MU���D�c�uH� �־~M�Y��&/v7_4��xe����.�uG� =��eL{w���qkBz�5��v�w]��6#ߵ͘�2���F�GN�@���B���1�F�dXU�T���1��[2��Y��uUyTW�3��. Section 3 deals with the impact of diversification on portfolio risk. (Arbitrage in bond prices) (a) The cash flow of Bond D can be generated by the portfolio consisting of 106=200 units of Bond C, 6=102 units of Bond B and (6 12=102)=100 units of Bond A. 0979. Since she is managing a stock mutual fund, she must remain invested in a portfolio of stocks. What is the most true regarding diversification? Define systematic risk. << /Length 5 0 R /Filter /FlateDecode >> Portfolio 1 is the most efficient portfolio as it gives us the highest return for the lowest level of risk. ... “Existing investment portfolio: aggressive Findings of risk-profiling questionnaire: conservative” It can greatly increase the risk of a portfolio. Thus: E(R p) = ΣW i R i where i = 1,2,3 … n. Where W i represents the weight attached to asset I and R i is the asset’s return. 1417 27 When combining risk though, there is a reduction in portfolio risk relative to the weighted average of the component ... 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