188 Financial Management If perfectly correlated: 20.000 , 30,000 , 40,000, Gaon can” ony 718700 + 26200 + 32,700 = & 77,600 4, Stocks A and B have the following historical returns: Year ‘Stack As Returns, 2009 (10.00" 2010 18.50 2onn 38.67 2012 1433 2o13. 33.00 (a) Calculate the average rate of return for each stock during the period 2009 through 2013. Assume that someone held a portfolio consisting of 50 per cent of Stock A and 50 per cent of Stock B. What would have been the realised rate of return on the portfolio in each year from 2009 through 2013? What would have been the average return on the portfolio during this period? (b) Now calculate the standard deviation of returns for each stock and for the folio, (© Looking atthe annual returns data on the two stocks, would you guess that the correlation coefficient between returns on the two stocks is closer to 0.9 or t0 0.97 (d) Ifyou added more stocks at random to the portfolio, which of the following is the most accurate statement of what would happen to 6, (1), would remain constant. (2), would decline to somewhere in the vicinity of 21 per cent. (3)¢, would decline to zero if enough stocks were included, Solution (a), The average rate of return for each stock is calculated simply by averaging the returns ‘over the 5-year period. The average retur for each stock is 18.90 per cent, calculated for Stock A as follows (10.00% + 18.50% + 38 = 18.90 M+ 14.38% + 38.00%)/5 “The realised rate of return on a portfolio made up of Stock A and Stack B would be calculated by finding the average return in each year as R, (Ye of Stock A) + R, (% of Stock B) and then averaging these yearly returns: Year Porijlio AB's Return, R,, 2009 (6.50%) 2010 1990 2out 4146 2012 9.00 2013, 30.65 3.90