Expected return = 0.4(0.05) + 0.6(0.15) = 0.02 + 0.09 = 0.11 or 11% 0000010277 00000 n 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. It is of little use to investors who wish to earn large returns. ... Let us now assume investments can be combined into a two-asset portfolio. �����]�y�*n~/M�Ev�3��X�`������І�Av��j���������V3t�8e�[�K6���e`6lˠ�Ao҈��9�*z�gzN����Uhi��� trailer Question: RISK AND RETURN You Own A Portfolio Consisting Of The Following Stocks. 0000008097 00000 n There are 20 questions in this test from the Portfolio Management section of the CFA Level 1 syllabus. 0000038699 00000 n ���s��6?Y��V#P9l`�'��R؃K�ӽ�N��_�RV*�yU���[���\��C�X��9�Ɂ�KzN�ْ�P�+��YJ����� � �V"�P�uw��0l0 8. b. answers you are looking at involve the examiner having algebraically-rearranged the formulae found on this sheet. <<9677f80f1c0983448a384dbcca936b1d>]>> The rate of return on the annuity is the same as the rate of return on US T-Bills. Describe the CAPM and explain what it does. Within the framework of modern portfolio theory, if portfolios A and B have the same return but portfolio A has less risk, then: The risk-free rate is 5.5%, and the market is in equilibrium. RISK AND RETURN This chapter explores the relationship between risk and return inherent in investing in securities, especially stocks. A portfolio comprises two securities and the expected return on them is 12% and 16% respectively. Please inform us if you spot any errors. 0000008875 00000 n 0000000016 00000 n 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��. Solutions to risk and return practice problems 4 . a. 0000001869 00000 n When combining risk though, there is a reduction in portfolio risk relative to the weighted average of the component ... All of the answers indicate that the higher risk exposure is the in Subsidiary A. Section 3 deals with the impact of diversification on portfolio risk. the concept of portfolio risk. Also The Expected Return On The Market Portfolio Is 15 Percent. a. total return … total risk b. expected return … total risk c. total return … systematic risk d. expected return … systematic risk 13. Open spreadsheet. Determine return of portfolio if first security constitutes 40% of total portfolio. Questions have also been Risk and Return: Portfolio Theory and Asset Pricing Models ANSWERS TO END-OF-CHAPTER QUESTIONS 0979. If markets are efficient, the price reflects CHAPTER 11 RISK AND RETURN: THE CAPITAL ASSET PRICING MODEL (CAPM) Answers to Concept Questions 1. Since the return of a portfolio is commensurate with the returns of its individual assets, the return of a portfolio is the weighted average of the returns of its component assets.The dollar amount of an asset divided by the dollar amount of the portfolio is the weighted average of the asset and the sum of all weighted averages must equal 100%. 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. 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. 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! 1417 0 obj <> endobj (That is, required returns equal expected returns.) 10 Key Points To Remember. 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. The portfolio risk is not simply a measure of its weighted average risk. 1. 0000009547 00000 n Questions and Answers ... CFA, is an analyst with a large money management firm. 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. endstream endobj 1443 0 obj<>/W[1 1 1]/Type/XRef/Index[56 1361]>>stream Example 3. Open the spreadsheet and perform the required analysis to answer the questions below. 0000001213 00000 n Risk and return questions and practice problems Risk and return part 2: Questions 1. 1417 27 Risk on Portfolio: The risk of a security is measured in terms of variance or standard deviation of its returns. a) 12.4% b) 13.4% c) 14.4% d) 15.4% View Answer / Hide Answer Susan is expecting the returns on the market portfolio to be negative in the near term. 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. 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. 0000008829 00000 n startxref The portfolio risk is not simply a measure of its weighted average risk. Risk and Return Problems and Solutions is set of questions and answers for risk and expected return and its associated cash flows. The above can be checked with the capital weightage formulas for the minimum variance (risk).Substituting It can greatly increase the risk of a portfolio. 0000006050 00000 n 0000003621 00000 n 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. On the other hand, there are some risks that affect all investments. Define systematic risk. Probability Possible rate of return 0.25 0.09 The securities consisting in a portfolio are associated with each other. 0000006738 00000 n 1420 0 obj<>stream 0000001558 00000 n The portfolio return r p = 0.079 with the risk σ p = 0. 0000003948 00000 n 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. Portfolio return is 12.98%. The price %��������� 0000007457 00000 n • Summaries, Key-terms, Questions and problems are provided at the end of sponding suggested answers. By investing in a variety of assets, this unique portion of the total risk can be eliminated at little cost. 0000003371 00000 n 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. The possible rate of return for a portfolio for an investment is shown below. 4 0 obj The risk premium of an asset is proportional to its beta. stream He also derived a formula for computing the variance/SD of a portfolio. 0000007867 00000 n 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. First we turn our attention to the concept of expected return. 0000002372 00000 n The concepts of systematic and unsystematic risk are introduced here. book Risk and Portfolio Analysis: principles and methods is not yet fully complete. c. Portfolio risk and return Prepared by Pamela Peterson Drake, Ph.D., CFA 1. 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. Risk of Portfolio of Two Assets: The risk of a security is measured in terms of variance or standard deviation of its returns. %PDF-1.5 %���� The data has been collected in the Microsoft Excel Online file below. Overview Security analysts and portfolio managers are concerned about an investment’s return, its risk, and whether it is priced correctly by the market. CHAPTER 1 Exercise 1.1. {\G����M�ѕ�y�C. 5. This result occurs because returns on A and B are not perfectly positively correlated (ρAB = 0.88). 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? 0000004694 00000 n i) Tax risk j) Etc 4. xref %PDF-1.3 Portfolio 1 is the most efficient portfolio as it gives us the highest return for the lowest level of risk. 0000003333 00000 n The expected return – beta relationship is the implication of the CAPM that security risk premiums (expected excess returns) will … Portfolio risk is increasingly dependent on the covariance of returns. Expected returns Portfolio risk Portfolio 1 23.20% 9.9% Portfolio 2 19.20% 10.0%. Individual ... it complicates the task of constructing portfolios with ‘efficient’ risk return trade-off due to the growth of possible asset combinations. View Test Prep - Risk and Return Practice Problems with Solutions.pdf from BA D1 at Brenau University. portfolio components, so there is no enhancement of portfolio return. You will get 30 minutes to complete the test. What is the market risk premium (r M - r RF)? Some of the risk in holding any asset is unique to the asset in question. Once we have risk and return for individual securities, we can then calculate portfolio risk and return. • 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 + Portfolio expected return is the sum of each of the individual asset’s expected return multiplied by its associated weight. 2. ... “Existing investment portfolio: aggressive Findings of risk-profiling questionnaire: conservative” 0000002012 00000 n 0000012948 00000 n 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. Let us try and find the answers to Joe’s questions. • Markowitz showed that the variance of the rate of return was a meaningful measure of portfolio risk under a reasonable set of assumptions. Answer. The securities consisting in a portfolio are associated with each other. Since she is managing a stock mutual fund, she must remain invested in a portfolio of stocks. 0000002905 00000 n Explain Markowitz Portfolio Theory? The weight attached to an asset = market value of asset/market value of portfolio. Find the portfolio return and risk Answer. 0000000873 00000 n (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. 0000003870 00000 n << /Length 5 0 R /Filter /FlateDecode >> ∴ Portfolio return is 12.98%. x���1 0ð4\ The beta is a relative measure of systematic risk. 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