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TUTORIAL 2

1. Use the information below to answer the following questions.

Return
Return on on
State Probability Stock A Stock B
1 18% 48% -18%
2 65% 8% 14%
3 16% 47% 45%
4 1% 18% 49%
a. Find the Expected Return on Stock A.
b. Find the Variance of the returns on Stock A.
c. Find the Standard Deviation of the returns on Stock A.

2. Find the Beta for Stock i given that the Expected Return on Stock i is 7.1%, the Expected
Return on the Market Portfolio is 7.1%, and the Risk-Free Rate is 2.8.

3. Find the Expected Return on Stock i given that the Expected Return on the Market
Portfolio is 11.6%, the Risk-Free Rate is 7.7%, and the Beta for Stock i is 0.8.

4. You own a portfolio consisting of the following stocks:

Stock Percentage of Beta Expected Return


portfolio
1 20% 1.00 16%
2 30% 0.85 14%
3 15% 1.20 20%
4 25% 0.60 12%
5 10% 1.60 24%
The risk rate is 3 percent. Also, the expected return on the market portfolio is 10.5 percent.

Required:

a. Calculate the expected return of your portfolio.


b. Calculate the portfolio beta
c. Given the preceding information, plot the security market line on paper. Plot the stocks
from your portfolio on your graph.
d. From your plot in part c, identify which stocks appear to be your winners and which ones
appear to be losers?
e. Describe why should you consider your conclusion in part d to be less than certain?
5. The following are monthly percentage price changes for four market indexes.

Month DJIA S&P 500 Russell 2000 Nikkei


1 0.03 0.02 0.04 0.04
2 0.07 0.06 0.10 -0.02
3 -0.02 -0.01 -0.04 0.07
4 0.01 0.03 0.03 0.02
5 0.05 0.04 0.11 0.02
6 -0.06 -0.04 -0.08 0.06

Required:

a. Average monthly rate of return for each index


b. Standard deviation for each index.
c. Covariance between the rates of return for the following indexes:

DJIA-S&P500
S&P 500 Russell 2000
S&P 500 Nikkei
Russell 2000 Nikkei

6. Assume that you expect the economys rate of inflation to be 3 percent, giving an RFR of
6 percent and a market return (RM) of 12 percent.

a. Draw the SML under these assumptions.


b. Subsequently, you expect the rate of inflation to increase from 3 percent to 6 percent.
What effect would this have on the RFR and the RM? Draw another SML on the
graph from Part a.
c. Draw an SML on the same graph to reflect an RFR of 9 percent and an RM of 17
percent. How does this SML differ from that derived in Part b? Explain what has
transpired.

7. Draw the implied SMLs for the following two sets of conditions:

a. RFR = 0.07; RM (S + P 500) = 0.16


b. Rz = 0.09; RM (True) = 0.18

Under which set of conditions would it be more difficult for a portfolio manager to be
superior?

8. Using the graph and equations from Problem 11, which of the following portfolios would
be superior?
a. Ra = 11%; = 0.09
b. Rb = 14%; = 1.00
c. Rc = 12%; = 0.40
d. Rd = 20%; = 1.10
Does it matter which SML you use?