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    Capm Questions

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    yen
    1. The document provides information to calculate expected returns, standard deviations, covariances, and correlations for two stocks, A and B, under different economic states. 2. It then repeats the calculations with updated state probabilities and calculates portfolio metrics for a mix of stocks A and B. 3. Additional calculations are shown for portfolio returns and variances given investments in assets with returns matching stocks A and B from the previous problems, and correlations between the assets are explored. 4. Leverage is introduced through borrowing, and its impact on risk and return of a stock portfolio is demonstrated. 5. A table is populated with security metrics including expected return, standard deviation, correlation with the market, and beta

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    Capm Questions

    Uploaded by

    yen
    80 views6 pages
    1. The document provides information to calculate expected returns, standard deviations, covariances, and correlations for two stocks, A and B, under different economic states. 2. It then repeats the calculations with updated state probabilities and calculates portfolio metrics for a mix of stocks A and B. 3. Additional calculations are shown for portfolio returns and variances given investments in assets with returns matching stocks A and B from the previous problems, and correlations between the assets are explored. 4. Leverage is introduced through borrowing, and its impact on risk and return of a stock portfolio is demonstrated. 5. A table is populated with security metrics including expected return, standard deviation, correlation with the market, and beta

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    Capm Questions

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    1. The document provides information to calculate expected returns, standard deviations, covariances, and correlations for two stocks, A and B, under different economic states. 2. It then repeats the calculations with updated state probabilities and calculates portfolio metrics for a mix of stocks A and B. 3. Additional calculations are shown for portfolio returns and variances given investments in assets with returns matching stocks A and B from the previous problems, and correlations between the assets are explored. 4. Leverage is introduced through borrowing, and its impact on risk and return of a stock portfolio is demonstrated. 5. A table is populated with security metrics including expected return, standard deviation, correlation with the market, and beta

    Copyright:

    © All Rights Reserved
    Download as XLS, PDF, TXT or read online from Scribd
    Download as xls, pdf, or txt
    80 views6 pages

    Capm Questions

    Uploaded by

    yen
    1. The document provides information to calculate expected returns, standard deviations, covariances, and correlations for two stocks, A and B, under different economic states. 2. It then repeats the calculations with updated state probabilities and calculates portfolio metrics for a mix of stocks A and B. 3. Additional calculations are shown for portfolio returns and variances given investments in assets with returns matching stocks A and B from the previous problems, and correlations between the assets are explored. 4. Leverage is introduced through borrowing, and its impact on risk and return of a stock portfolio is demonstrated. 5. A table is populated with security metrics including expected return, standard deviation, correlation with the market, and beta

    Copyright:

    © All Rights Reserved
    Download as XLS, PDF, TXT or read online from Scribd
    Download as xls, pdf, or txt
    of 6
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    The passage discusses portfolio analysis and risk metrics like expected return, standard deviation, covariance and correlation under different economic states and probability distributions.

    When state probabilities change, the expected returns, standard deviations and correlations of the stocks will change accordingly based on the new probability weights.

    Leverage increases both the expected return and risk of an investment. Borrowing to invest amplifies gains in up states but also increases losses in down states, leading to higher portfolio standard deviation.

    1 Suppose you have two stocks, A and B, whose returns depend no the state of the economy in the following

    way
    State Return on A Return on B
    Bear 6.3% -3.7%
    Normal 10.5% 6.4%
    Bull 15.6% 25.3%
    If each state is equally likely, find the expected and the standard deviation of returns for each stock.
    Find the covariance and correlation of the returns on stocks A and B.

    2 Redo problem 1, but now suppose that the three states have the following probabilities
    State Probability
    Bear 25.0%
    Normal 60.0%
    Bull 15.0%

    3 Suppose your portfolio holds $300,000 worth of stock A and $1,100,000 worth of stock B.
    Using the data from problems 1 and 2, find the expected return, standard deviation and variance of your portfolio.

    4 Suppose you invest $1.39 in an asset with the same mean and standard deviation of returns as asset A in problem 1, abov
    You also invest $2.34 in an asset with the same mean and standard deviation as asset B in problem 2, above.
    Find the mean and variance of the returns on your portfolio if the returns on A and B have a correlation of 0.5.
    How does your answer change if their correlation is -0.5?
    Explain why this makes sense.

    5 Suppose you invest $100,000 in a stock with the following possible returns

    State Probability Return


    Bear 25.0% 6.3%
    Normal 60.0% 10.5%
    Bull 15.0% 15.6%

    but half of this money has been borrowed (interest free) and must be repaid.
    What is the expected return and standard deviation of returns on the portfolio consisting of my stocks and my debts?
    Why is this different from what we saw for Stock A in problem 2?

    6 Complete the following table


    Expected Standard Correlation
    Security Return Deviation with Market Beta
    A 0.13 0.12 0.9
    B 0.16 0.4 1.1
    C 0.25 0.24 0.75
    Market Index 0.15 0.1
    Risk-free bill. 0.05
    omy in the following way

    each stock.

    variance of your portfolio.

    turns as asset A in problem 1, above.


    B in problem 2, above.
    ve a correlation of 0.5.

    g of my stocks and my debts?


    1 State Return on A Return on B Deviation A Deviation B Sq Dev A
    Bear 6.3% -3.7% -4.5% -13.0% 0.202500%
    Normal 10.5% 6.4% -0.3% -2.9% 0.000900%
    Bull 15.6% 25.3% 4.8% 16.0% 0.230400%
    Mean 10.8% 9.3% 0.0% 0.0% 0.144600%
    Std. Dev. 3.8% 12.0%
    Covariance 0.454%
    Correlation 99.3%

    2 State Return on A Return on B Probability Deviation A Deviation B


    Bear 6.3% -3.7% 25.0% -3.9% -10.4%
    Normal 10.5% 6.4% 60.0% 0.3% -0.3%
    Bull 15.6% 25.3% 15.0% 5.4% 18.6%
    Mean 10.2% 6.7% 0.0% 0.0%
    Std. Dev. 2.9% 8.9%
    Covariance 0.252%
    Correlation 98.6%

    3 A B Portfolio Probability Deviation


    Cash Value $ 300,000 $ 1,100,000 $ 1,400,000
    Weight 21.43% 78.57% 100%
    Bear 6.3% -3.7% -1.6% 25.0% -9.0%
    Normal 10.5% 6.4% 7.3% 60.0% -0.2%
    Bull 15.6% 25.3% 23.2% 15.0% 15.8%
    Mean 10.2% 6.7% 7.5% 0.0%
    Std. Dev. 7.59%

    4 A B Portfolio
    Cash Value $ 1.39 $ 2.34 $ 3.73
    Weight 37.27% 62.73% 100%
    Mean 10.8% 6.7% 8.2%
    Std. Dev. 3.8% 8.9%

    Correlation(A,B) 50.0% -50.0%


    Covariance(A,B) 0.16898% -0.16898% from the definition of correlation
    Port. Variance 0.41% 0.25% Using the formulaJust the weighted average of the two!
    Port. Std. Dev. 6.40% 5.02% Negative correlations means we get more diversification.

    5 State Probability Return Deviation Sq. Deviation


    Bear 25.0% 6.3% -3.91500% 0.153272%
    Normal 60.0% 10.5% 0.28500% 0.000812%
    Bull 15.0% 15.6% 5.38500% 0.289982%
    Mean 10.21500% 0.00000% 0.08230%
    Variance 0.08230%
    Std. Dev. 2.86885%

    B A Portfolio Asset B is our interest free loan!


    Cash Value -$ 50,000.00 $ 100,000.00 $ 50,000.00
    Weight -100.00% 200.00% 100% Same formulas as in previous problem!
    Mean 0.0% 10.21500% 20.4% Same formulas as in previous problem!
    Std. Dev. 0.0% 5.0%
    Correlation(A,B) 0.0% Since the return on the loan is known!
    Covariance(A,B) 0.00000% from the definition of correlation
    Port. Variance 1.01% Same formulas as in previous problem!
    Port. Std. Dev. 10.04% Higher risk due to leverage!

    6 Expected Standard Correlation


    Security Return Deviation with Market Beta
    A 0.13 0.12 0.75 0.9 use ==>
    B 0.16 0.275 0.4 1.1 Same
    C 0.25 0.24 0.75 1.875 Same
    Market Index 0.15 0.1 1 1 Always!
    Risk-free bill. 0.05 0 0 0 Easy!
    Sq Dev B Dev A * Dev B
    1.698678% 0.586500%
    0.086044% 0.008800%
    2.549344% 0.766400%
    1.444689% 0.453900%

    Sq Dev A Sq Dev B Dev A * Dev B


    0.153272% 1.083681% 0.407552%
    0.000812% 0.000961% -0.000883%
    0.289982% 3.455881% 1.001072%
    0.082303% 0.789879% 0.251519%

    Sq Dev.

    0.8133%
    0.0003%
    2.4839%
    0.6%

    ed average of the two!


    get more diversification.

    nterest free loan!

    as in previous problem!
    as in previous problem!
    Remember that Beta = cov(A,M) / Var(M)
    Cov(A,M) = corr(A,M)*stdev(A)*stdev(M)
    so Beta = corr(A,M)*stdev(A)/Stdev(M)

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