Question 1

An investor who is in possession of a portfolio consisting of 5 assets (A – E), decides to sell

two assets. He decides that he will sell assets B and E and keep a portfolio of three assets (A,
C and D).
(i) Calculate the expected rate of return of the portfolio with three assets.
(ii) By assuming that the risk of the portfolio remains unchanged when the number of
assets is decreased to three, explain whether the investor took a good decision by
reducing the number of assets.
Expected
rate of
Asset Weight return/ %
A 0.2 10
B 0.2 5
C 0.2 8
D 0.2 9
E 0.2 7

Question 2
Given the following market values of stocks in your portfolio and their expected rates of
return, what is the expected rate of return for your common stock portfolio?

Stock (i) Market Value (Rs) E (Ri)

Morgan Stanley 15,000 0.14
Starbucks 17,000 -0.04
General Electric 32,000 0.18
Intel 23,000 0.16
Walgreens 7,000 0.12

Question 3
An investor is considering acquiring shares from Madison Company and Lauren Company.
The stocks of the two companies have the following possible returns:
Madison Company
Possible Rate of Return Probability
-0.1 0.1
-0.05 0.05
0.1 0.2
0.2 0.65

Lauren Company
Possible Rate of Return Probability
-0.9 0.1
-0.4 0.05
-0.3875 0.2

1
 0.5 0.65

(i) Calculate the expected rates of return of the stocks of Madison Company
and Lauren Company.
(ii) Explain which of the two stocks is riskier, without doing any
calculations.
(iii) A rational investor will buy stocks from Madison Company or Lauren
Company? Explain.
Question 4
Investor constitutes a portfolio by investing equal proportions in stocks A and B.
Financial Situation Probability Return Stock A Return Stock B
Good 0.4 20% 10%
Stable 0.4 5% 0%
Bad 0.2 - 5% 20%

(i) Calculate the expected rate of return of the portfolio.

(ii) Calculate the covariance between the returns of stocks A and B.
(iii) Calculate the risk of the portfolio.

Question 5
A portfolio consists of assets A and B, which possess the following expected return, risk and
weights.
Standard
Expected Deviation/
Asset return/ % % Weight
A 10 20 0.35
B 15 25 0.65

(i) What correlation between the two assets produces the maximum portfolio standard
deviation?
(ii) What correlation between the two assets produces the minimum portfolio standard
deviation?
For both parts (i) and (ii) of this question, show your calculations.