If you create a portfolio for your client with 73 percent invested in the S&P 500 U.S. stock index (which includes T) and the remaining 27 percent in the Vanguard Gold index. The expected return is 30 percent for the S&P 500 and 3 percent for the Vanguard Gold index. The risk is 7.5 percent for the S&P 500 and 5 percent for the Vanguard Gold index. Estimate the portfolio’s return and risk given that the correlation coefficient between the S&P 500 and the Vanguard Gold index is -0.3? (e) Evaluate the effect of a change in the correlation coefficient to 0.8 on the portfolio’s return and risk. (f) If you are interested in constructing a portfolio with 20% in the U.S energy sector and 80% in the U.S. consumer staples sector, which Exchange Traded Funds (ETF) could you use?
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.
If you create a portfolio for your client with 73 percent invested in the S&P 500 U.S. stock index (which includes T) and the remaining 27 percent in the Vanguard Gold index. The expected return is 30 percent for the S&P 500 and 3 percent for the Vanguard Gold index. The risk is 7.5 percent for the S&P 500 and 5 percent for the Vanguard Gold index. Estimate the portfolio’s return and risk given that the correlation coefficient between the S&P 500 and the Vanguard Gold index is -0.3?
(e) Evaluate the effect of a change in the correlation coefficient to 0.8 on the portfolio’s return and risk.
(f) If you are interested in constructing a portfolio with 20% in the U.S energy sector and 80% in the U.S. consumer staples sector, which Exchange Traded Funds (ETF) could you use?
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