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Wednesday, December 11, 2019

Portfolio Valuation

Questions: Consider shares in two companies, JAY and KAY, as follows: Expected Return E(R) Standard Deviation s Correlation Coefficient r Share JAY 12% 18% 0.3 Share KAY 24% 32% a) Calculate the covariance between Share JAY and KAY returns. b) What is the expected return and standard deviation of returns on a portfolio comprising 35% in Share JAY and 65% in Share KAY? c) If you wanted to create a portfolio consisting only of these two shares, how much would you need to invest (weights) in each share so that your portfolio return would be equal to 15.6%? Note: do not round. d) Using the weights calculated in part c), calculate the variance and standard deviation of your portfolio. Answers: a) We know, = -0.3 x = 0.18 y= 0.32 = cov/ x * y Thus cov = -0.3* .18* 0.32 = -0.01728 b) Expected return = w* R = 0.35* 12% + 0.65* 24% = 19.8 Standard deviation = (wi * wj * i * j * cov(i,j) ) ^ 0.5 = 20.8 c) Let investment in Jay be x Thus investment in Kay will be (1- x) Expected return = w* R = x* 12% + (1-x)* 24% 15.6 = 12x +24 -24x X = 0.7 Thus investment in Jay = 70% d) Variance = wi * wj * i * j * cov(i,j) = 214.632 Standard deviation = (wi * wj * i * j * cov(i,j) ) ^ 0.5 = 14.65. References Return, Risk And The Security Market Line - Expected Return, Variance And Standard Deviation Of A Portfolio. Advanced Bond Concepts: Bond Pricing. Dividend Discount Model DDM.

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