Portfolio Effect on Risk and Return

ERC INSTITUTE get wind Kimberly Limanto Student ID 1004434 Course Name SADBA Title Of The Course Investment and neckcloth Management Date of Submission 15 November 2012 Instructor Name Mr. Johnson Yang skirt OF CONTENTThe Financial advisors coronation property case Inferior investment alternatives Although investing requires the individual to bear risk, the risk stooge be controlled finished the construction of diversified portfolios and by excluding any portfolio that offers an low return for a given amount of risk. While this concept seems obvious, whiz of your clients, Laura Spegele, is considering purchasing a conduct she get out bear. To convince her that the acquisition is not desirable, you want to depict the trade-off amid risk and return.While it is impractical to show the trade-off for all(a) possible combinations, you believe that illustrating several combinations of risk and return and applying the akin analysis to the specific investment should be pe rsuasive in discouraging the purchase. Currently, US Treasury bills offer 7%. Three possible bourgeons and their beta atomic number 18 as follows- SecuritiesExpected ReturnBeta Stock A9%0. 6 Stock B 11%1. 3 Stock C 14%1. 5 Required I. What will be the anticipate return and beta for each of the following ? portfolios? a.Portfolio 1 by government agency of 4 all of the funds are invested solely in whiz asset ? (the corresponding three stocks or the Treasury bill) b. Portfolio 5 whizz quarter of the funds are invested in each alternative c. Portfolio 6 one half of the funds are invested in stock A and the other half in stock C. d. Portfolio 7 One ternion of the funds are invested in each stock. II. Are any of the portfolios ineffective? III. Is there any combination of the Treasury bill and Stock C that is top-notch to portfolio 6 (i. e. half the funds in Stock A and half in Stock C)? IV.Since your clients suggested stock has an judge return of 12% and a beta of 1. 4 does t hat information cope for or against the purchase of the ? stock? V. Why is it important to consider purchasing an asset as part of a portfolio ? and not as an freelancer act? Answers I. Expected Return and Beta of each portfolio. a. All of the funds are invested solely in one asset. * Portfolio 1 100% in investment T-Bill E(R) = 7% E (beta) = 0. 0 * Portfolio 2 100% investment in Stock A E(R) = 9% E (beta) = 0. 6 * Portfolio 3 100% investment in Stock B E(R) = 11%E (beta) = 1. 3 * Portfolio 4 100% investment in Stock C E(R) = 14% E (beta) = 1. 5 b. Portfolio 5 25% investment in each security E(R) = (0. 25*0. 07) + (0. 25*0. 09) + (0. 25*0. 11) + (0. 25*0. 14) = 0. 0175 + 0. 0225 + 0. 0275 + 0. 035 = 0. 1025 = 10. 25% E (beta) = (0. 25*0. 0) + (0. 25*0. 6) + (0. 25*1. 3) + (0. 25*1. 5) = 0 + 0. 15 + 0. 325 + 0. 375 = 0. 85 c. Portfolio 6 50% investment in Stock A, 50% investment in Stock B E(R) = (0. 5*0. 09) + (0. 5*0. 14) = 0. 045 + 0. 07 = 0. one hundred fifteen = 11. 5% E (beta) = (0. 5*0. 6) + (0. 5*1. 5) = 0. 3 + 0. 75 = 1. 05 . Portfolio 7 one-third investment in each security E(R) = (0. 33*0. 09) + (033*0. 11) + (0. 33*0. 14) = 0. 03 + 0. 036 + 0. 046 = 0. 1122 = 11. 22% E (beta) = (0. 33*0. 6) + (0. 33*1. 3) + (0. 33*1. 5) = 1. 12 apiece Portfolio returns and beta 100% in T-bill 7% 0. 0 100% in stock A 9% 0. 6 100% in stock B 11% 1. 3 100% in stock C 14% 1. 5 25% in each 10. 25% 0. 85 50% in A and C 11. 5% 1. 05 1/3 in each stock 11. 22% 1. 12 II. Inefficient portfolio is a portfolio where the pass judgment risk is higher than the pass judgment return in their comparison.In this case, portfolio 3 where the investment is 100% invested in stock B is the most inefficient because its expected return is 11% and its beta is 1. 3 while in portfolio 6 the expected return is slightly higher, which is 11. 5%, but the beta is lower, which is 1. 05. Therefore from this, we can conclude that portfolio 3, or when she invest 100% in stock B, is the most inefficient portfolio. III. The portfolio which combines 50% investment in stock A and 50% investment in stock C generates an expected return of 11. 5% and beta of 1. 05.The combination on investment between T-Bill and stock C that will be superior to the previous portfolio is E (beta) = 1. 05 = X% * 0. 0 + Y% * 1. 5 = 1. 05 = 0 + Y% * 1. 5 = 1. 05 Y% = 1. 5/1. 05 Y% = 0. 7 = 70% X% = 100% 70% = 30% E(R) = (0. 3*0. 07) + (0. 7*0. 14) = 0. 021 + 0. 098 = 0. 119 = 11. 9% The portfolio which combines 30% or less investment in T-Bill and 70% or much investment in stock C will e superior to portfolio 6 which combine 50% investment in stock A and 50% investment in stock C. IV. The portfolio that the client suggested which has 12% expected return and 1. beta is inferior compared to any other portfolio. To eject that this portfolio is inferior to another portfolio, we can try to calculate by Beta of 1. 4 is a combine of 93% investment in stock C and 7% investment in T-bill. Calculation (0. 07*0. 0) + (0. 93*1. 5) = 1. 4 This portfolio will generate an expected return of (0. 07*0. 07) + (0. 93*0. 14) = 0. 0049 + 0. 1302 = 0. 1351 = 13. 51% This calculation prove that a beta of 1. 4 suppose to give 13. 51% expected return. Therefore, the clients suggested portfolio is inferior compared to any other portfolio.V. Purchasing an asset as a part of a portfolio is a much clever way than and purchasing one single asset. It is because by purchasing several assets, the investor can either have higher return with the same risk, or same return but with a lower risk. Therefore, purchasing to a greater extent than one asset will give benefits to the investor. Also, by purchasing in more than one asset, the investor can be more safe. What safe means is when the other asset collapse, or its value decline, there are button up other assets that can cover the losses.