Problems

2.1 Warren Buffett, arguably the most famous investor in the United States, is the CEO of
Berkshire Hathaway (BRK), a company that has enjoyed great success in terms of its stock
price. Below are the actual year-end stock prices for BRK-A from 1965 through 2011. (Yes,
these are the actual stock prices, believe it or not.)

a) Calculate the return relatives for each year starting in 1966. Use two decimal places.
b) Calculate the arithmetic mean and geometric mean for these price relatives, using three
decimal places.
c) Calculate the cumulative wealth index for 1966 - 2011, assuming an initial investment
of $1,000, and $10,000. State the answers without decimal places.

Year Year-End Price Year Year-End Price

1965 16.25 1989 8,675.00
1966 17.50 1990 6,675.00
1967 20.25 1991 9,050.00
1968 37.00 1992 11,750.00
1969 42.00 1993 16,325.00
1970 39.00 1994 20,400.00
1971 70.00 1995 32,100.00
1972 80.00 1996 34,100.00
1973 71.00 1997 46,000.00
1974 40.00 1998 70,000.00
1975 38.00 1999 56,100.00
1976 94.00 2000 71,000.00
1977 138.00 2001 75,600.00
1978 157.00 2002 72,750.00
1979 320.00 2003 84,250.00
1980 425.00 2004 87,900.00
1981 560.00 2005 88,620.00
1982 775.00 2006 109,990.00
1983 1,310.00 2007 141,600.00
1984 1,275.00 2008 96,600.00
1985 2,470.00 2009 99,200.00
1986 2,820.00 2010 120.450.00
1987 2,950.00 2011 114,755.00
1988 4,700.00 ….

2.2 The Mom and the Pop Grocery Store is incorporated and has shares of stock that are now
worth $10 per share. A financial analysis of the store indicates four equally likely states or
outcomes:

State Probability Share Price Dividend

Struggling 0.25 $5 $0
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 Status Quo 0.25 $10 $0
Slow Growth 0.25 $12 $0
Good Times 0.25 $14 $1

Compute the mean, standard deviation, and variance of the returns of the common stock of
Mom and Pop Grocery Store Corporation.

2.3 Super Store, Inc., is considering the purchase of two supermarkets at opposite ends of the
town of Lehigh, Pennsylvania. The south store has an expected return of 0.12 and a variance
of 0.0900, the north store has an expected return of 0.14 and a variance of 0.0625, and together
they have a covariance of -0.0500.

Compute the expected return (mean) and variance of the portfolio of returns found with $6
million invested in the south store and $4 million invested in the north store.

2.4 The following table is for Problems a through c

Probability Rates of Returns on Stocks

1 2 3
0.20 0.24 0.16 0.02
0.25 0.18 0.12 0.07
0.30 0.10 0.08 0.10
0.15 -0.01 0.04 0.13
0.10 -0.12 0.02 0.21
a) Compute the expected rate of return for each of three stocks.
b) Compute the variance and standard deviation for the three stocks
c) Compute the population covariance and the correlation coefficient between stocks 1
and 2 and between stocks 1 and 3.

2.5. The data below are annual total returns for General Foods (GF) and Sigma Technology
(ST) for the period 1997 - 2011.

Year GF ST
2011 -0.141 0.222
2010 0.203 0.079
2009 -0.036 -0.220
2008 -0.204 0.527
2007 0.073 -0.628
2006 -0.111 0.684
2005 0.023 1.146
2004 0.291 0.564
2003 0.448 0.885
2002 0.482 0.433
2001 0.196 0.516
2000 0.103 -0.056
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 1999 0.075 0.153
1998 0.780 1.207
1997 0.254 0.736
Sigma Technology is highly regarded by many investors for its innovative products. It had
returns more than twice as large as that of General Foods. What would have been the results
if an investor had placed half her funds in General Foods and half in Sigma Technology during
this 15-year period in order to try to earn a larger return than that available in General Foods
alone? Would the risk have been too large?

a) Calculate the arithmetic mean returns for each stock.

b) Calculate the standard deviation for each stock using the STDEV function in the
spreadsheet.
c) Calculate the correlation coefficient using the CORREL function in the spreadsheet.
d) Calculate the covariance using the COVAR function in the spreadsheet.
e) Calculate the portfolio return assuming equal weights for each stock.
f) Set up a calculation for the standard deviation of the portfolio that will allow you to
substitute different values for the correlation coefficient or the standard deviations of the
stocks. Using equal weights for the two stocks, calculate the standard deviation of the
portfolio consisting of equal parts of the two stocks.
g) How does the portfolio return compare to the return on General Foods alone? How does
the risk of the portfolio compare to the risk of having held General Foods alone?
h) Assume that the correlation between the two stocks had been -0.10. How much would
portfolio risk have changed relative to the result calculated in f ?

2.6 Fill in the spreadsheet below to calculate the portfolio return and risk between Zenon and
Dynamics, given the 10 years of annual returns for each stock, and portfolio weights of 50/50.

Zenon Dynamics
Expected Return
Variance
Standard Deviation
Covariance
Weight 50% 50%

Expeted Portfolio Return

Portfolio Variance
Portfolio Standard Deviation

Zenon Ret Dynamics Ret

2011 9.89% -47.67%
2010 -12.34% 30.79%
2009 13.56% 24.78%
2008 34.56% 7.89%
2007 -15.23% 24.42%
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 2006 20.09% 34.56%
2005 7.56% 67.56%
2004 16.47% 44.67%
2003 18.34% 78.56%
2002 15.56% 51.00%

a) How would your answer change if the weights were 40 percent for Zenon and 60
percent for Dynamics?
b) How would your answer change if the weights were 30 percent for Zenon and 70
percent for Dynamics?

2.7 Closing prices for SilTech and New Mines for the years 1997 - 2012 are shown below.

a) Calculate the total returns for each stock for the years 20121998 to 3 decimal places.
Note that the price for 1997 is used to calculate the total return for 1998.
b) Assume that similar returns will continue in the future (i.e., average returns 5 expected
returns). Calculate the expected return, variance and standard deviation for both stocks and
insert these values in the spreadsheet. Use Average, Var, and Stdev functions.
c) Calculate the covariance between these two stocks based on the 15 years of returns.
d) Using the 11 different proportions that SilTech could constitute of the portfolio ranging
from 0% to 100% in 10% increments, calculate the portfolio variance, standard deviation and
expected return.
e) Plot the tradeoff between return and risk for these two stocks based on the calculation
in (d). Use the XY scatter diagram in Excel.

GF ST
2012 198,080 21,634
2011 84,080 34,867
2010 71,890 44,670
2009 32,200 49,800
2008 10,690 49,550
2007 7,160 46,860
2006 10,950 53,110
2005 7,440 48,750
2004 25,700 63,120
2003 10,230 37,040
2002 3,280 31,670
2001 5,220 21,780
2000 7,970 14,450
1999 9,640 9,390
1998 7,130 14,990
1997 14,390 10,720

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 2.8 Answer the following questions.
a) Suppose Asset A has an expected return of 10% and a standard deviation of 20%. Asset
B has an expected return of 16% and a standard deviation of 40%. If the correlation between
A and B is 0.35, what are the expected return and standard deviation for a portfolio consisting
of 30% Asset A and 70% Asset B?
b) Plot the attainable portfolios for a correlation of 0.35. Now plot the attainable portfolios
for correlations of +1.0 and −1.0.
c) Suppose a risk-free asset has an expected return of 5%. By definition, its standard
deviation is zero, and its correlation with any other asset is also zero. Using only Asset A and
the risk-free asset, plot the attainable portfolios.