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# 1.     Estimate the Security Market Line of the 5 stocks using the data in your spreadsheet.

2.     Compute the tangency and MVP portfolios. You may treat the average return on each stock as the expected return on that stock.

MVP Weights
ALL 5.27% Total of weights 100%
CAT 7.00% Variance 0
LMT 14.70% Std Dev 2.85%
DOW 10.87% Mean 8.83%
BUD 62.16% SR 2.28

## Tangency Portfolio Weights

ALL 64.5% Total of weights 100%
CAT 38.5% Variance 0
LMT 47.2% Std Dev 5.27%
DOW -20.9% Mean 24.53%
BUD -29.4% SR 4.21

3.     Explain the following two puzzles briefly

a.      BUD has the lowest average returns but highest positive portfolio weight in the MVP portfolio.

We suspect this is occurring for one of two reasons: First, the standard
deviation of BUD is the lowest of the group. This makes it an acceptable
security to introduce into a diversified portfolio. Second, judging by the
β of BUD compared to the others, you can see that BUD has the least
amount of correlation in terms of all of the other securities. This also
aids in its precedence when speaking of its weight in the MVP.

b.     CAT has the highest excess return. Yet, its portfolio weight in the tangency portfolio is not the highest.

Although CAT does have the highest excess return, its level of risk is
also quite considerable. According to our data, CAD and LMT have the
highest risk of all the securities in our portfolio. The objective of the
tangency portfolio is to maximize return for a given risk level. CAT
does, in deed, give us a heavy return, but at the exposure to more risk
then would be safe to apply a heavy weight in our portfolio.
4.     Re-compute the tangency and MVP portfolios by imposing a constraint that all the portfolio weights have to be positive.

*Note: re-computing the MVP would be redundant under these restraints due to the fact that the original MVP required no shorting.

## Tangency with no short Weights

ALL 39.27% Total of weights 100%
CAT 25.71% Variance 0.00162
LMT 35.02% Std Dev 4.02%
DOW 0.00% Mean 18.60%
BUD 0.00% SR 4.05

a.      Compare the standard deviation and Sharpe ratio of constrained and unconstrained portfolios?
The σ and sharp ratio are obviously more favorable without the
constraint set. Again, the objective of the tangency portfolio is to
maximize gain at a given risk. We are attempting to maximize this
return/risk ratio by maximizing our sharp ratio. Without the
constraints being placed, it gives the calculation free reign as to
whichever combination of weights it deems fit (while still being total
weight of 100%). In essence, the maximum return/risk ratio will be
given when there are no constraints embedded in the calculation.
5.     Re-compute the tangency and MVP portfolios by recalculating the expected return on stocks (this problem assumes NO constraints)

a.      Use the CAPM equation to calculate expected returns?

## MVP with CAPM returns Weights

ALL 5.27% Total of weights 100%
CAT 7.00% Variance 0
LMT 14.70% Std Dev 2.85%
DOW 10.87% Mean 4.56%
BUD 62.16% SR 0.78

## Tangency with CAPM returns Weights

ALL 11.76% Total of weights 100%
CAT 38.66% Variance 0
LMT -21.87% Std Dev 4.89%
DOW 28.02% Mean 8.89%
BUD 43.42% SR 1.34
b.     Comment on the difference between portfolio weights in part 2 and 5.

## Problem 2 MVP Tangency

ALL 5.27% 64.53%
CAT 7.00% 38.53%
LMT 14.70% 47.19%
DOW 10.87% -20.88%
BUD 62.16% -29.37%
Problem 5 MVP Tangency
ALL 5.27% 11.76%
CAT 7.00% 38.66%
LMT 14.70% -21.87%
DOW 10.87% 28.02%
BUD 62.16% 43.42%

As you can see, there was no change in the weights from problem 2-5 in
terms of the MVP portfolio. This was due to the fact that even though
the E ( r ) figures were based upon a new model, the σ values were still
the same. Therefore, the minimum variance portfolio (which attempts
to minimize risk will gaining the most return) would maintain its
position. Aside that, we found it interesting that the securities that
problem 2 shows a short position, problem 5 has a significant long
position. Likewise, the only security that is short in the problem 5
tangency portfolio makes up a nearly 50% long position in problem 2!

6.     Plot the efficiency frontier of only the 5 risky assets.

Efficient frontier sheet

Covariance
Exp. Return ALL CAT LMT DOW BUD
ALL 17% 0.002 0.001 0.001 0.001 0.001
CAT 23% 0.001 0.006 0.000 0.003 0.000 show our formula
LMT 17% 0.001 0.000 0.004 0.000 0.000 methodology, the
DOW 10% 0.001 0.003 0.000 0.006 0.000 rest is hard-coded
BUD 4% 0.001 0.000 0.000 0.000 0.001

## Weights 5.3% 7.0% 14.7% 10.9% 62.2%

ALL 5.3% 0.00001 0.00000 0.00000 0.00001 0.00002
CAT 7.0% 0.00000 0.00003 0.00000 0.00002 0.00000
LMT 14.7% 0.00000 0.00000 0.00008 0.00001 0.00003
DOW 10.9% 0.00001 0.00002 0.00001 0.00007 0.000
BUD 62.2% 0.00002 0.00000 0.00003 -0.00001 0.00046
Total of weights
100.0%
Variance 0.000813
Std Dev 2.85%
Mean 8.83%
SR 2.28

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Efficient frontier sheet

## Mean Std Dev ALL CAT LMT DOW BUD

25.00% 5.38 66.30% 39.48% 48.19% -21.83% -32.14%
24.00% 5.14 62.55% 37.47% 46.10% -19.81% -26.30%
23.00% 4.91 58.77% 35.46% 44.03% -17.79% -20.47%
22.00% 4.68 55.01% 33.45% 41.95% -15.77% -14.64%
21.00% 4.46 51.24% 31.44% 39.88% -13.75% -8.80%
20.00% 4.25 47.44% 29.43% 37.82% -11.72% -2.97%
19.00% 4.05 43.66% 27.42% 35.75% -9.70% 2.86%
18.00% 3.85 39.89% 25.41% 33.68% -7.67% 8.70%
17.00% 3.67 36.13% 23.40% 31.59% -5.65% 14.53%
16.00% 3.50 32.35% 21.39% 29.52% -3.63% 20.36%
15.00% 3.79 28.56% 19.39% 27.46% -1.60% 26.19%
14.00% 3.20 24.78% 17.38% 25.39% 0.42% 32.03%
13.00% 3.08 21.02% 15.36% 23.31% 2.44% 37.86%
12.00% 2.99 17.25% 13.35% 21.24% 4.46% 43.69%
11.00% 2.92 13.45% 11.35% 19.19% 6.49% 49.53%
10.00% 2.87 9.68% 9.34% 17.11% 8.51% 55.36%
9.00% 2.85 5.92% 7.33% 15.03% 10.54% 61.19%
8.00% 2.86 2.14% 5.32% 12.96% 12.56% 67.03%
7.00% 2.90 -1.65% 3.31% 10.90% 14.58% 72.86%
6.00% 2.96 -5.41% 1.30% 8.82% 16.61% 78.69%
5.00% 3.05 -9.21% -0.71% 6.76% 18.63% 84.53%

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Efficient frontier sheet

5.38 25.00%
5.14 24.00%
4.91 23.00%
4.68 22.00% Efficient Frontier
4.46 21.00% 25.00%
4.25 20.00% 24.00%
23.00%
4.05 19.00% 22.00%

20.00%

## 3.67 17.00% 19.00%

18.00%
3.50 16.00% 17.00%
16.00%
3.34 15.00%
Return

15.00%

13.00%

## 3.08 13.00% 12.00%

11.00%
2.99 12.00% 10.00%
9.00%
2.92 11.00% 8.00%

## 2.87 10.00% 7.00%

6.00%
2.85 9.00% 5.00%
4.00%
2.86 8.00% 2
.75
3 3
.25
3.5 3
.75
4 4
.25
4.5 4
.75
5 5
.25
5.5

2.90 7.00% σ

2.96 6.00%
3.05 5.00%

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DATE ALL CAT LMT DOW BUD Market Rfree
AVG 1.42% 1.90% 1.44% 0.85% 0.36% 0.73% 0.19%
σ 4.96% 7.66% 6.07% 7.51% 3.50% 3.61% 0.12%
β 0.57 1.34 -0.19 1.08 0.22 1.00 0.00
E( r ) 17.09% 22.75% 17.25% 10.24% 4.33% 8.72% 2.33%
Check using slope 0.58 1.37 -0.19 1.10 0.22 1.00 0.00
SML Er=2.33+β(8.72-2.33)

## Stock β E(r) SML

ALL 0.6 5.99% 0.11
CAT 1.3 10.92% 0.11
0.1
LMT -0.2 1.12% 0.1
0.09
DOW 1.1 9.26% 0.09
BUD 0.2 3.72% 0.08
0.08
Market 1.0 8.72% 0.07
0.06
This is the CAPM E( r ) data used for problem 5.
E(r)

0.06 Column C
0.06
0.05
0.05
0.04
MVP Weights 0.04
ALL 5.27% Total of weights 100% 0.03
0.03
CAT 7.00% Variance 0 0.02
0.02
LMT 14.70% Std Dev 2.85% 0.01
-0.25 0 0.25 0.5 0.75 1 1.25 1.5
DOW 10.87% Mean 8.83% β
BUD 62.16% SR 2.28

## Tangency Portfolio Weights

ALL 64.5% Total of weights 100%
CAT 38.5% Variance 0
LMT 47.2% Std Dev 5.27%
DOW -20.9% Mean 24.53%
BUD -29.4% SR 4.21

## Tangency with no short Weights

ALL 39.27% Total of weights 100%
CAT 25.71% Variance 0
LMT 35.02% Std Dev 4.02%
DOW 0.00% Mean 18.60%
BUD 0.00% SR 4.05
Problem 5 supporting data

CAPM Returns ALL CAT LMT DOW BUD
ALL 5.99% 0.002 0.001 0.001 0.001 0.001
CAT 10.92% 0.001 0.006 0.000 0.003 0.000
LMT 1.12% 0.001 0.000 0.004 0.000 0.000
DOW 9.26% 0.001 0.003 0.000 0.006 0.000
BUD 3.72% 0.001 0.000 0.000 0.000 0.001

## Weights 5.3% 7.0% 14.7% 10.9% 62.2%

ALL 5.3% 0.00001 0.00000 0.00000 0.00001 0.00002
CAT 7.0% 0.00000 0.00003 0.00000 0.00002 0.00000
LMT 14.7% 0.00000 0.00000 0.00008 0.00001 0.00003
DOW 10.9% 0.00001 0.00002 0.00001 0.00007 0.000
BUD 62.2% 0.00002 0.00000 0.00003 -0.00001 0.00046
Total of weights 100.0%
Variance 0.000813
Std Dev 2.85%
Mean 4.56%
SR 0.78

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