Question

< 087c3bf05caf46f2ae409104186c6b97.xlsx 6 Q No.3 Economy Recession Normal Good Boom Probability 20% 35% 35% 10% Stocks -5% 10% 14% 18% Bonds 15% 12% 11% 9% Part A 1. Calculate expected return and standard deviation of each stock and bonds. 2. Which investment is less risky based on standard deviation? Part B (part B will be solved separately from part A. You can only take data from question number 3 and make portfolio. In case of any problem recheck zoom recording of Session 3) Being investor you decided to invest 60% in stocks and 40% in bonds. 1. Calculate portfolio expected return 2. Calculate portfolio standard deviation 3. Compare portfolio risk with individual stocks and bonds investment as you did in part A and suggest which option is better only stocks, only bonds or portfolio in terms of risk and return.

Answer 1

Expected Return =Mean Return =SUMOf ((Probability)*(Return)) Variance of Return=Sum of (Probability* (Deviation “2)) Deviation =Return - Mean Return Standard Deviation of Return =Square Root of Variance of Return ANALYSIS OF STOCKS p R1 A1=R1*P D1=R1-9.2 E1=(D1^2) F1=p*E1 Probability Deviation *Return(% Squared(% Probability*Deviatio State of Economy Probability Return(%) ) Deviation(%) %) n Squared(%%) Recession 20% (5.00) -1 (14.20) 201.64 40.328 Normal 35% 10.00 3.5 0.80 0.64 0.224 Good 35% 14.00 4.9 23.04 8.064 Boom 10% 18.00 1.8 8.80 77.44 7.744 SUM 9.2 56.36 Expected Return =Mean return 9.20% Variance of Return 56.36 %% Standard Deviation of Return =SQRT(56.36)= 7.51% 4.80 SUM

9.2 SUM 56.36 STOCK SUM Expected Return =Mean return 9.20% Variance of Return 56.36 %% Standard Deviation of Return =SQRT(56.36)= 7.51% ANALYSIS OF BONDS р R2 A2=R2*p D2=R2-11.95 E2=(D2^2) F2=p*E2 Probability Deviation *Return % Squared(% Probability *Deviatio State of Economy Probability Return(%) ) Deviation(%) %) n Squared(%%) Recession 20% 15 3 3.05 9.3025 1.8605 Normal 35% 12 4.2 0.05 0.0025 0.000875 Good 35% 11 3.85 -0.95 0.9025 0.315875 Boom 10% 9 0.9 -2.95 8.7025 0.87025 SUM 11.95 SUM 3.0475 Expected Return =Mean return 11.95% Variance of Return 3.0475 %% Standard Deviation of Return =SQRT(3.0475)= 1.746% BOND IS LESS RISKY, IT HAS LOWER STANDARD DEVIATION

Return ANALYSIS OF PORTFOLIO PORTFOLIO RETURN =w1R1+w2R2 w1=Weight of Investment in Stock 0.6 w2=Weight of investment in Bond 0.4 R1=Return of Stock, R2=Return of Bond p R1 R2 Rp=0.6*R1+0.4R2 p Rp Dp=Rp-10.3 Ep Fp=pEp Probabil Probability Deviation of Deviatio ity Devi Stock Bond Portfolio Return Portfolio Portfolio n ation State of Economy Probability Return(%) Return (%) (%) Return Squared Squared Recession 20% (5.00) 15 3.00 0.60 (7.30) 53.29 10.66 Normal 35% 10.00 12 10.80 3.78 0.50 0.25 0.09 Good 35% 14.00 11 12.80 4.48 2.50 6.25 2.19 Boom 10% 18.00 9 14.40 1.44 4.10 16.81 1.68 SUM 10.30 SUM 14.61 Expected Return =Mean return of Portfolio 10.30% Variance of Return 14.61 %% Standard Deviation of Return =SQRT(14.61)= 3.823% REWARD RISK RATIO(Mean Return /Standard Deviation) Stocks=9.2/7.51= 1.23 Bond=11.95/1.746= 6.85 Portfolio=10.3/3.823= 2.69 ONLY BOND IS BETTER, REWARD/RISK IS HIGHEST