ESSENTIALS OF INVESTMENTS SELECT CHAPT
17th Edition
ISBN: 9781307126228
Author: Bodie
Publisher: MCG/CREATE
expand_more
expand_more
format_list_bulleted
Videos
Textbook Question
Chapter 6, Problem 5PS
The standard deviation of the market-index portfolio is 20%. Stock A has a beta of 1.5 and a residual standard deviation of 30%. (LO 6-5)
a. What would make for a larger increase in the stock’s variance: an increase of 0.15 in its beta or an increase of 3% (from 30% to 33%) in its residual standard deviation?
b. An investor who currently holds the market-index portfolio decides to reduce the portfolio allocation to the market mdcx to 90% and to invest 10% in stock A. Which of the changes in (a) will have a greater impact on the portfolios standard deviation?
Expert Solution & Answer
Trending nowThis is a popular solution!
Students have asked these similar questions
An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 25%
while the standard deviation on stock B is 15%. The correlation coefficient between the return on A and B is 0.40.
What is the standard deviation of return on the minimum variance portfolio? Do not enter % in the answer box. For
example, if your answer is 0.12345 or 12.345% then enter as 12.35 in the answer box.
The expected return and standard deviation of Stock A are 12% and 24%, respectively. The expected return and standard deviation of Stock B are 5% and 19%, respectively. The correlation between the two stocks is 0.4. The risk-free rate in the economy is 1%.
A. What is the Sharpe ratio for Stock A and Stock B?
Show your calculation steps briefly and clearly.
B. Calculate the optimal risky portfolio P*.
You do not need to show your calculation steps for this subquestion.
C. Now suppose that the correlation between the two stocks is -0.2 (instead of 0.4). Re-calculate the optimal risky portfolio P* and compare it to your answer in Part B. What do you observe?
You do not need to show your calculation steps for this subquestion.
D. Using the results above, briefly explain why investors might still consider investing in stocks with a (relatively) low Sharpe ratio as a part of their portfolio.
16.
There are two stocks with the following return and risk values. The correlation between A and B is 0.2.
al
Expected Standard
Return(%) Deviation(%)
Stock
A
5.5
10
B
7.5
17
What is the standard deviation of the minimum variance portfolio(MVP) that is
a)
formed by combining assets A and B? (That is, what are the weights of stock A and stock B in
MVP?)
b)
What is the expected return of the portfolio P that is formed by investing 50% on the
MVP and 50% on a stock that has an expected return of 10%?
c) Assume that the only assets available to investors are the risk free asset and the
portfolio P. The risk free rate is 2%. Assume also that there is $100 to be invested. What is the
expected return of a NEW portfolio that is formed by combining risk free rate with a weight of -0.5
and portfolio P with a weight of 1.5? What does a negative weight mean? Explain with one
sentence
Chapter 6 Solutions
ESSENTIALS OF INVESTMENTS SELECT CHAPT
Ch. 6 - Prob. 1PSCh. 6 - When adding a risky asset to a portfolio of many...Ch. 6 - A portfolio’s expected return is 12%, its standard...Ch. 6 - An investor ponders various allocations to the...Ch. 6 - The standard deviation of the market-index...Ch. 6 - Suppose that the returns on the stock fund...Ch. 6 - Use the rate-of-return data for the stock and bond...Ch. 6 - Prob. 8PSCh. 6 - Prob. 9PSCh. 6 - Prob. 10PS
Ch. 6 - Prob. 11PSCh. 6 - Prob. 12PSCh. 6 - Prob. 13PSCh. 6 - Suppose that many stocks are traded in the market...Ch. 6 - You can find a spreadsheet containing annual...Ch. 6 - Assume expected returns and standard deviations...Ch. 6 - Prob. 17PSCh. 6 - Prob. 18PSCh. 6 - A project has a 0.7 chance of doubling your...Ch. 6 - Investors expect the market rate of return this...Ch. 6 - The following figure shows plots of monthly rates...Ch. 6 - Prob. 22PSCh. 6 - Prob. 23PSCh. 6 - Prob. 25CCh. 6 - Prob. 1CPCh. 6 - Prob. 2CPCh. 6 - Abigail Grace has a $900,000 fully diversified...Ch. 6 - Prob. 4CPCh. 6 - Prob. 5CPCh. 6 - Prob. 6CPCh. 6 - Prob. 7CPCh. 6 - Prob. 1WMCh. 6 - Following the procedures in the previous question,...Ch. 6 - Prob. 3WMCh. 6 - Prob. 4WM
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Stock A has expected return of 15% and standard deviation (s.d.) 20%. Stock B has expected return 20% and s.d. 15%. The two stocks have a correlation coefficient of 0.5. 1.Note that Stock A has greater risk (s.d.) that Stock B, but a lower expected return. Explain how is this possible in a world where returns on assets are as predicted by the CAPM. 2. Determine the expected return and the s.d. of portfolio P1, composed by investing 30% in stock A and 70% in stock B. 3. Consider stock C that has expected return 15% and s.d. 15%. Stock C is uncorrelated with either stock A and stock B. Determine the expected return and s.d. of portfolio P2 made by investing 50% in stock C and 50% in portfolio P1.arrow_forwardPlease helparrow_forwardGiven the following information on three stocks assuming: Stock Expected Return A 0.06 0.1 0.267 Assume further the following portfolio co-variances: AB = 0, AC = 0 and BC -0.05333. Now suppose you diversify into two securities. Given the three choices of possible portfolio combinations, can any portfolio be eliminated because it is dominated by at least one of the other portfolio combinations? Assume equal weights. Select one: B с Standard Deviation a. Portfolio (A,B) should be eliminated b. Portfolio (A,C) should be eliminated c. Portfolio (B,C) should be eliminated d. Portfolio (A,B) and Portfolio (A,C) should be eliminated e. Portfolio (A,B) and Portfolio (B,C) should be eliminated f. Portfolio (A,C) and Portfolio (B,C) should be eliminated No Portfolio dominates the others. 0 0.25 0.375arrow_forward
- Suppose that optimal risky portfolio has an expected return of 16% and a varianceof 0.04. The risk-free rate is 4%.a) Find the slope of Capital Market Line (Optimal Capital Allocation Line)?b) What is the expected return of a portfolio C, which is on Capital Market Line and has astandard deviation of 0.08?arrow_forwardAssume the CAPM holds and consider stock X, which has a return variance of 0.09 and a correlation of 0.75 with the market portfolio. The market portfolio's Sharpe ratio is 0.30 and the the risk-free rate is 5%. (a) What is Stock X's expected return? (b) What proportion of Stock X's return volatility (i.e. standard deviation) is priced by the market? Explain why this number is less than 1.arrow_forwardi need the answer quicklyarrow_forward
- Please answer asap Suppose you create a minimum-variance portfolio by combining two perfectly negatively correlated stocks, CRT and DMV. The expected return is 20% on CRT and 10% on DMV. The standard deviation is 20% for CRT and 15% for DMV. What is the standard deviation of your portfolio? A. 0.14 B. 0.16 C. 0.01 D. 0.12arrow_forwarda. Use the following information: E[rXOM] = 15.6%, standard deviationXOM = 15.9% E[rMS]=29.7%, standard deviationMS = 35.2% Correlation of returns: ρXOM,MS = 0.139, rf=10% If the optimal amount to invest in the first asset (w) is 0.43, what is the variance of the risky portfolio when w=0.43? (write in decimal format using 5 decimal places) b. When choosing the best point of the POS (the curved line connecting two possible assets you can invest in) you need to find the point that: 1.Has the greatest difference between it’s return and the risk free rate, thus leading to the best return 2. You must solve for the optimal y allocation in order to find the best point on the POS 3. The point with the lowest standard deviation 4. The point with the greatest Sharpe ratioarrow_forwardA person is interested in constructing a portfolio. Two stocks are being considered. Letx = percent return for an investment in stock 1, and y = percent return for an investment instock 2. The expected return and variance for stock 1 are e(x) = 8.45% and Var(x) = 25.The expected return and variance for stock 2 are e(y) = 3.20% and Var(y) = 1. Thecovariance between the returns is sxy = −3.a. what is the standard deviation for an investment in stock 1 and for an investment instock 2? Using the standard deviation as a measure of risk, which of these stocks isthe riskier investment?arrow_forward
- Suppose the market risk premium is 9 % and also that the standard deviation of returns on the market portfolio is 0.26 . Further assume that the correlation between the returns on ABX (Barrick Gold) stock and returns on the market portfolio is 0.62 , while the standard deviation of returns on ABX stock is 0.36 . Finally assume that the risk-free rate is 2 %. Under the CAPM, what is the expected return on ABX stock? (write this number as a decimal and not as a percentage, e.g. 0.11 not 11%. Round your answer to three decimal places. For example 1.23450 or 1.23463 will be rounded to 1.235 while 1.23448 will be rounded to 1.234)arrow_forwardWhich statement is correct? The collection of all portfolios that minimize variance for varying levels of expected return is called the efficient frontier. The mean-variance frontier is the top-half of the efficient frontier. The part of efficient frontier with the highest expected return for a given level of variance is called the mean- variance frontier. The collection of all portfolios out of risky asset that minimize variance for varying levels of expected return is shaped like a hyperbola.arrow_forwardConsider the following information: State of Economy Probability of State of Economy Rate of Return if State Occurs Stock A Stock B Stock C Boom 0.58 0.08 0.17 0.37 Bust 0.42 0.11 0.04 -0.06 a. What is the expected return on an equally weighted portfolio of these three stocks? (Do not round intermediate calculations. Round the final answer to 2 decimal places.) Expected return % b. What is the variance of a portfolio invested 20% each in A and B and 60% in C? (Do not round intermediate calculations. Round the final answer to 6 decimal places.) Variance =arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
Investing For Beginners (Stock Market); Author: Daniel Pronk;https://www.youtube.com/watch?v=6Jkdpgc407M;License: Standard Youtube License