The Table below shows the returns for three stocks, and portfolios of Pairs of Stocks Stock Returns Portfolio Returns Year North Air West Air Tex Oil 1/2RN + 1/2W 1/2RW + 1/2T 2010 21% 9% -2% 15.0% 3.5% 2011 30% 21% -5% 25.5% 8.0% 2012 7% 7% 9% 7.0% 8.0% 2013 -5% -2% 21% -3.5% 9.5% 2014 -2% -5% 30% -3.5% 12.5% 2015 9% 30% 7% 19.5% 18.5% Average Return 10.0% 10.0% 10.0% 10.0% 10.0% Volatility 13.4% 13.4% 13.4% 21.1% 5.1% Required 1.From the three stocks in the above table, comment on the volatility and average return, and the pattern of the returns 2.Which portfolio (combination of stocks), eliminated the highest risk? And what could be the plausible reason for that? 3. Compute the covariance and correlation between pairs of stocks (North Air & West Air ; and West Air and Text oil)
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.
The Table below shows the returns for three stocks, and portfolios of Pairs of Stocks
|
|
Stock Returns |
Portfolio Returns |
|||
|
Year |
North Air |
West Air |
Tex Oil |
1/2RN + 1/2W |
1/2RW + 1/2T |
|
2010 |
21% |
9% |
-2% |
15.0% |
3.5% |
|
2011 |
30% |
21% |
-5% |
25.5% |
8.0% |
|
2012 |
7% |
7% |
9% |
7.0% |
8.0% |
|
2013 |
-5% |
-2% |
21% |
-3.5% |
9.5% |
|
2014 |
-2% |
-5% |
30% |
-3.5% |
12.5% |
|
2015 |
9% |
30% |
7% |
19.5% |
18.5% |
|
Average Return |
10.0% |
10.0% |
10.0% |
10.0% |
10.0% |
|
Volatility |
13.4% |
13.4% |
13.4% |
21.1% |
5.1% |
Required
1.From the three stocks in the above table, comment on the volatility and average return, and the pattern of the returns
2.Which portfolio (combination of stocks), eliminated the highest risk? And what could be the plausible reason for that?
3. Compute the covariance and correlation between pairs of stocks (North Air & West Air ; and West Air and Text oil)
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