Question

ICA 4A Spring 2020 - Word Search Layout References Mailings Review View Help Aa A L AaBbccI AaBbCel AaBb C AaBbcc -DA EE. .. 1 Normal 1 No Spac... Heading 1 Heading 2 A Paragraph Styles FIN 3510 ICA #4A Spring 2020 A. You have a $20,000 to invest in a portfolio. You want to put $6000 investment into Delta (Del) and a $14000 investment into Gamma (Gam). State of the Economy Probability E(RD) E(R) Wi % 14.00 Boom Normal Recession Depression 0.15 0.55 0.15 0.15 6.00 10.00 13.00 14.00 9.00 0.00 -5.00 a. Calculate the portfolio expected return, E(R). o 1 e 29 w TSUS

Answer 1

Given for two security:

State of economy	Probability	Expected return delta	Expected return Gamma
Boom	0.15	6%	14%
Normal	0.55	10%	9%
Recession	0.15	13%	0%
Depression	0.15	14%	-5%

Expected return of a security is sum of probability of statemultiplied by its expected return

Expected return of Delta E(D) = 0.15 *6 + 0.55*10 + 0.15*13 + 0.15*14 = 10.45%

Expected return of Gamma E(G) = 0.15*14 + 0.55*9 + 0.15*0 - 0.15*5 = 6.3%

When 6000 is invested in Delta, and 14000 in Gamma

Expected return of portfolio is weighted average return on its assets

So, E(p) = (6000*10.45 + 14000*6.3)/20000 = 7.545%

So, expected return on portfolio is 7.545%