How would you characterize the correlation of returns of the two stocks L and M? e. Discuss any benefits of diversification achieved by Jamie through creation of the portfolio
How would you characterize the correlation of returns of the two stocks L and M? e. Discuss any benefits of diversification achieved by Jamie through creation of the portfolio
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Question
Jamie Wong is thinking of building an investment portfolio containing two stocks, L and M. Stock L will represent 50% of the dollar value of the portfolio, and stock M will account for the other 50%.
The historical returns over the next 6 years, 2013−2018,for each of these stocks are shown in the following table: (see attached table)
d. How would you characterize the correlation of returns of the two stocks L and M?
e. Discuss any benefits of diversification achieved by Jamie through creation of the portfolio.
Transcribed Image Text:### Expected Return on Stocks: A Comparative Analysis
#### Yearly Expected Returns for Stock L and Stock M
The table provided below illustrates the expected return on investment for two different stocks, Stock L and Stock M, over a period of six years, from 2013 to 2018. Expected returns are expressed in percentage terms for each year.
| Year | Stock L | Stock M |
|------|---------|---------|
| 2013 | 15% | 22% |
| 2014 | 17% | 21% |
| 2015 | 19% | 20% |
| 2016 | 21% | 19% |
| 2017 | 22% | 18% |
| 2018 | 24% | 17% |
### Analysis
- **Stock L**: There is a consistent increase in the expected return for Stock L over the six years. Starting from 15% in 2013, the return rises progressively each year, reaching 24% in 2018.
- **Stock M**: The expected return for Stock M shows a declining trend over the same period. It starts at 22% in 2013 and decreases each year, ending at 17% in 2018.
The data suggests that while Stock L has shown a steady growth in expected returns, Stock M has experienced a gradual decline. This can be indicative of varying performance metrics, market conditions, or company health affecting these stocks differently over time.
### Interpretation
Investors reviewing this data would likely consider Stock L as a more favorable option due to its consistent growth in expected returns. However, it's essential for investors to also consider risk factors, market conditions, and their investment strategy before making a decision.
### Educational Note
Understanding the historical performance of stocks is crucial for making informed investment decisions. This table is a useful tool for illustrating how expected returns can fluctuate over time and helps in comparing different investment opportunities.
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