Portfolio Effect on Risk and Return

ERC INSTITUTE relate Kimberly Limanto pupil ID ane hundred4434 mannequin Name SADBA Title Of The Course Investment and Fund Management interpret of Submission 15 November 2012 Instructor Name Mr. Johnson Yang TABLE OF CONTENTThe Financial advisors investiture case Inferior enthronisation funds alternatives Although investing requires the individual to bear take a chance, the risk rat be controlled through the verbalism of diversified portfolios and by excluding any portfolio that offers an humble diminish for a given heart of risk. While this concept seems obvious, ane of your invitees, Laura Spegele, is considering buying a received she willing bear. To incline her that the acquisition is not desirable, you want to install the trade-off between risk and give birth.While it is romantic to show the trade-off for all mathematical combinations, you believe that illustrating some(prenominal) combinations of risk and return and applying the homogeneous ana lysis to the specific coronation should be persuasive in deter the purchase. Currently, US Treasury levels offer 7%. Three possible line of businesss and their genus Beta argon as follows- SecuritiesExpected lightBeta expect A9%0. 6 hold B 11%1. 3 transmission line C 14%1. 5 required I. What will be the evaluate return and important for to from each one whiz of the following ? portfolios? a.Portfolio 1 through 4 all of the bills are invested solely in one asset ? (the corresponding three shops or the Treasury bill) b. Portfolio 5 one run of the property are invested in each alternative c. Portfolio 6 one fractional of the funds are invested in stocktaking A and the other half in stock C. d. Portfolio 7 One tercet of the funds are invested in each stock. II. Are any of the portfolios inefficient? III. Is in that location any combination of the Treasury bill and line of business C that is crack to portfolio 6 (i. e. half the funds in line of merchandise A an d half in Stock C)? IV.Since your clients suggested stock has an judge return of 12% and a beta of 1. 4 does that information argue for or against the purchase of the ? stock? V. Why is it all-important(prenominal) to consider buy an asset as wear of a portfolio ? and not as an independent act? Answers I. Expected Return and Beta of each portfolio. a. All of the funds are invested solely in one asset. * Portfolio 1 100% in investing T-Bill E(R) = 7% E (beta) = 0. 0 * Portfolio 2 100% coronation in Stock A E(R) = 9% E (beta) = 0. 6 * Portfolio 3 100% investment in Stock B E(R) = 11%E (beta) = 1. 3 * Portfolio 4 100% investment in Stock C E(R) = 14% E (beta) = 1. 5 b. Portfolio 5 25% investment in each protective cover E(R) = (0. 25*0. 07) + (0. 25*0. 09) + (0. 25*0. 11) + (0. 25*0. 14) = 0. 0175 + 0. 0225 + 0. 0275 + 0. 035 = 0. 1025 = 10. 25% E (beta) = (0. 25*0. 0) + (0. 25*0. 6) + (0. 25*1. 3) + (0. 25*1. 5) = 0 + 0. 15 + 0. 325 + 0. 375 = 0. 85 c. Portfolio 6 50% inv estment in Stock A, 50% investment in Stock B E(R) = (0. 5*0. 09) + (0. 5*0. 14) = 0. 045 + 0. 07 = 0. 115 = 11. 5% E (beta) = (0. 5*0. 6) + (0. 5*1. 5) = 0. 3 + 0. 75 = 1. 05 . Portfolio 7 one-third investment in each security E(R) = (0. 33*0. 09) + (033*0. 11) + (0. 33*0. 14) = 0. 03 + 0. 036 + 0. 046 = 0. 1122 = 11. 22% E (beta) = (0. 33*0. 6) + (0. 33*1. 3) + (0. 33*1. 5) = 1. 12 Each Portfolio returns and beta 100% in T-bill 7% 0. 0 100% in stock A 9% 0. 6 100% in stock B 11% 1. 3 100% in stock C 14% 1. 5 25% in each 10. 25% 0. 85 50% in A and C 11. 5% 1. 05 1/3 in each stock 11. 22% 1. 12 II. ineffectual portfolio is a portfolio where the evaluate risk is high than the expect return in their comparison.In this case, portfolio 3 where the investment is 100% invested in stock B is the most inefficient because its evaluate return is 11% and its beta is 1. 3 while in portfolio 6 the expected return is slightly high, which is 11. 5%, besides the beta is pull down, which is 1. 05. Therefore from this, we can refrain that portfolio 3, or when she invest 100% in stock B, is the most inefficient portfolio. III. The portfolio which combines 50% investment in stock A and 50% investment in stock C generates an expected return of 11. 5% and beta of 1. 05.The combination on investment between T-Bill and stock C that will be superior to the previous portfolio is E (beta) = 1. 05 = X% * 0. 0 + Y% * 1. 5 = 1. 05 = 0 + Y% * 1. 5 = 1. 05 Y% = 1. 5/1. 05 Y% = 0. 7 = 70% X% = 100% 70% = 30% E(R) = (0. 3*0. 07) + (0. 7*0. 14) = 0. 021 + 0. 098 = 0. 119 = 11. 9% The portfolio which combines 30% or less(prenominal) investment in T-Bill and 70% or more investment in stock C will e superior to portfolio 6 which combine 50% investment in stock A and 50% investment in stock C. IV. The portfolio that the client suggested which has 12% expected return and 1. beta is inferior compared to any other portfolio. To examine on that this portfolio is inferior to another portfoli o, we can try to calculate by Beta of 1. 4 is a combine of 93% investment in stock C and 7% investment in T-bill. Calculation (0. 07*0. 0) + (0. 93*1. 5) = 1. 4 This portfolio will generate an expected return of (0. 07*0. 07) + (0. 93*0. 14) = 0. 0049 + 0. 1302 = 0. 1351 = 13. 51% This deliberateness prove that a beta of 1. 4 suppose to give 13. 51% expected return. Therefore, the clients suggested portfolio is inferior compared to any other portfolio.V. purchase an asset as a part of a portfolio is a much tricksy way than just purchasing one single asset. It is because by purchasing several assets, the investor can either have higher return with the same risk, or same return but with a lower risk. Therefore, purchasing more than one asset will give benefits to the investor. Also, by purchasing in more than one asset, the investor can be more near. What safe means is when the other asset collapse, or its value decline, there are passive other assets that can cover the losses.