Question

Consider the following assets available for investment: 1. A stock index fund 2. A corporate bond fund 3. A utility fund 4. A global fund 5. A treasury fund You have research on the funds that has projected out the expected returns (in percent) for the funds along with the probabilities of those returns occurring. The following table shows the expectations: probability CBFUF SIF -18 Rec 15 -5 GF TE -20 3 -10 153 N Rec -7 wwww norm .3 5 12 | 20 6 2 n boom .2 25 boom .15 Your assignment is to analyze the risk and return metrics of these assets and answer the following questions: 1. What is the expected return of each asset? 2. What is the standard deviation of each asset? 3. What is the Sharpe Ratio of each asset, using the treasury fund as the risk free asset? (Note, the treasury fund will not have Sharpe ratio because it is the risk free asset) 4. Using the stock index fund as the "market", what is the Beta of each asset? 5. If you were only going to invest in one of these assets, would it be more appropriate to use standard deviation or Beta as your measure of risk, and why? 6. Which asset, if held as a single investment, gives you the best reward for the risk you have taken? 7. Diagram the Security Market Line (assuming the stock index fund is the market and the treasury fund is the risk free asset), plotting the assets in their appropriate places. 8. Which assets are considered “underpriced" and which are considered "overpriced based on the SML?

Answer 1

1) Expected return(Summation of Prob*expected return): SIF-> 0.15*-18+0.2*-7+0.3*12+0.2*20+0.15*25 = 7.25%

Likewise CBF-> 3.4%

UF-> 4.4%

GF-> 9.75%

TF-> 3%

2) For finding SD apply->

Σ α – )2 και probability

where x- returns

  $\overline{x}$-expected returns

Therefore SD-> SIF-> 14.92

CBF-> 2.39

UF-> 6.88

GF-> 19

TF-.> 0

3) Sharpe ratio- (Expected return-risk free return)/SD

SIF-> 0.28

CBF-> 0.17

UF-> 0.2

GF-> 0.36

4) Beta= (Expected return-risk free return)/(Market return-risk free return)

SIF-> 1

CBF->0.09

UF-> 0.32

GF-> 1.58

TF-> 0