3598 words - 15 pages

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Student Name: LEE TAE JEONG

Student #: 7573103

Assignment Reference #: IPM/Jul11/1, Investment and Portfolio Management

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Investment and Portfolio Management Assignment 1 ******************************************************************************

A table of Contents

Q1. Portfolio Management

Q-a: What’s the least risky combination of these assets?

Q-b: How much James should invest in the portfolio (comprising of security A, B) and risk free asset (RFR)

with 9% of return provided ?

Q2: Analysis of the article of Wall street journal

a) Why did Merck’s price fall so ...view middle of the document...

And the portfolio should include all of your assets and liabilities, not only your marketable securities but also less marketable investments. The full spectrum of investments must be considered because the returns from all these investment interacts, and this relationship among the returns for assets in the portfolio is important.

Portfolio theory also assumes that investors are basically risk averse, meaning that they will select the assets

with the lower level of risk, the uncertainty of future outcomes or the probability of an adverse outcome.

Q-a: What’s the least risky combination of these assets?

R(A) = 0.125 with ((A) = 0.2, R(B) = 0.105 with ((B) = 0.15, ((AB) = 0.4

The general equation for the weight of the first security to achieve minimum variance in a two-stock portfolio is given by X(A) = [ ((B)^2 - ((A) ((B) ((AB)] / [((A)^2 + ((B)^2 – 2((A) ((B) ((AB)]

So X(A) = [0.15^2 – (0.2*0.15*0.4)] / [(0.15^2 + 0.2^2) – (2*0.15*0.2*0.4)] = 0.0105 / 0.0285 = 0.2727 (27%)

The least risky combination of the two stock portfolios is to invest 27.3% in security A and 72.7% in security B.

((p)^2 = X(A)^2 * ((A)^2 + X(B)^2 * ((B)^2 + 2 X(A) X(B) ((A) ((B) ((AB) = 0.0196

And Standard deviation of the portfolio ((p) = 0.1401

Expected return = X(A) R(A) + X(B) R(B) = 0.2727 x 0.125 + 0.7272 x 0.105 = 0.1104 (11.04%)

For any two risky assets the three most extreme outcomes are

1) The risky assets correlate completely ,where ((AB) = 0

2) The risky assets are correlated less than completely. In this case portfolio variance will fall.

3) The risky assets are negatively correlated. In this case major reductions in variance are available and risk can be completely eliminated if ((AB) = -1.0

Q-b: How much James should invest in the portfolio (comprising of security A, B) and risk free asset (RFR) with 9% of return provided?

Return = 0.09, RFR = 0.0225, E(Rm) (market risk) = 0.1104

Risky asset is one from which future returns are uncertain which is measured by the variance or standard deviation of expected returns. Because the expected return on a risk-free asset is entirely certain, the standard deviation of its expected return is zero and also correlation between any risky assets and risk-free assets will be zero as well.

And this question is to illustrate the Markowitz’ efficient portfolio change to CML(Capital Market Line) by

adding risk-free assets in portfolio by borrowing or lend at the risk-free rate of return as illustrated in graph-1.

Expected return E(R) = X(RF)*RFR + (1-X(RF))*E(Rm)

Where:

X(RF) = the proportion of the portfolio invested in the risk-free assets

E(Rm) = the expected rate of return on risky Portfolio M (referring to graph-1)

0.09 = X(RF)*0.0225 + (1-X(RF))*0.1104

X(RF) = 0.2321 (23.2%)

James could further reduce the risk with excess risk provided he can earn an return 9%...

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