A firm has a portfolio composed of stock A and B with normally distributed returns. Stock A has an annual expected return of 15% and annual volatility of 20%. The firm has a position of $100 million in stock A. Stock B has an annual expected return of 25% and an annual volatility of 30% as well. The firm has a position of $50 million in stock B. The correlation coefficient between the returns of these two stocks is 0.3. a. Compute the 5% annual VAR for the portfolio. Interpret the resulting VAR. b. What is the 5% daily VAR for the portfolio? Assume 365 days per year.
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
A firm has a portfolio composed of stock A and B with
a. Compute the 5% annual VAR for the portfolio. Interpret the resulting VAR.
b. What is the 5% daily VAR for the portfolio? Assume 365 days per year.
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