RISK AND RETURN

a) Phương pháp bình quân (cho dữ liệu các năm quá khứ)
r 1+ r 2+r 3+ …
Expected return (Lợi tức kì vọng) : r = n

( r 1−r )2+ ( r 2−r )2 + ( r 3−r )2

Variance (phương sai) : σ 2=
n−1

Độ lệch chuẩn (standard deviation) = √ σ 2 = σ

b) Phương pháp phân phối xác suất (cho xác suất (probalibity) của các kì vọng)

Expected return (Lợi tức kì vọng): r = P1.r1 + P2.r2 + P3.r3 + …

Variance (phương sai) : σ 2=¿P1.(r1 – r )^2 + P2.(r2-r )^2 + P3.(r3 – r )^2 + …

Độ lệch chuẩn ( standard deviation) = √ σ 2

Hiệp phương sai (pp trung bình) (covariance):

( X 1−X ) . ( Y 1−Y ) + ( X 2−X ) . ( Y 2−Y ) +…

Cov(x,y) = n−1

Hiệp phương sai (pp xác suất) (covariance):

Cov ( x , y ) =P1. ( X 1− X ) . ( Y 1−Y ) + P 2. ( X 2−X ) . (Y 2−Y )+ …

 Cov ( x , y )
Hệ số tương quan (correlation coefficient): p=
σX . σY
=> Cov = p.σX . σY

Er−rF Risk premium

Sharp ratio = σ = Standard deviation

c) danh mục đầu tư (Risky portfol`io - P)

giá trị đầu tư vào A
Portfollio weight = wA =
tổng đầu tư

Expected return (Lợi tức kì vọng): E(r) = wA.rA + wB.rB

Variance (phương sai) : σ 2=w X 2 . σX 2 +w Y 2 . σ Y 2+ 2. wX . wY . σX . σY . p

2 2 2 2 2
σ =w X . σX +w Y . σ Y + 2. wX . wY .cov ( X ,Y )

Độ lệch chuẩn (standard deviation) = √ σ 2

Utility (U)
Complete Porfolio (C)

+ Risk-free assets (F) => rF

+ Risky assets (Risky portfolio – P) => rP

Gọi:

y (wP) : Tỷ trọng đầu tư vào risky assets (P)

1–y (wF) : Tỷ trọng đầu tư vào risk-free assets (F)

Expected return E (rC) = wP.rP + wF.rF

Độ lệch chuẩn σ ( C )=℘ . σP

rP−rF
Tỷ trọng tối ưu hóa danh mục C : y* = 2
A.σ

CAL = sharp ratio . σ + rF

Optimal Risky Portfolio (S + B)
Rs . σ b2−Rb . cov (s , b)
wS= 2 2
Rs . σ b + Rb . σ s −( Rs+ Rb ) . cov (s , b)

wB = 1 – wS
Trong đó:
Rs = rS – rF (risk premium of S)
Rb = rB – rF (risk premium of B)
Mininum Variance Portfolio
2
σ b −cov (s , b)
wS= 2 2
σ b +σ s −2.cov (s ,b)

wB = 1 – wS

Capital Asset Pricing Model (CAPM)

E(r) = rF + B.(rM – rF)

rf : risk free
rM : market return
rM – rF : market risk premium

Bond Pircing
 1−( 1+r )−n F
PV = C . + n
r (1+r )
Trong đó:
C: coupon payment
c : coupon rate
r : YTM
F: face value
n : year to maturity

Pricing 1-year
P0 : PV in year 0
P1: PV in year 1 (YTM year 1)
P1’: PV in year 1 (YTM year 0)

Capital gain = P1 – P1’

Total interest = P1’ – P0 + C

P 1−P 0+ C
1-year HPR of bond =
P0
P 1−P 0+ C−Taxes
After – tax 1-year HPR of bond =
P0

Duration:
t CF PVt wt wt * t t^2 + t wt * t
1
2
3

Duration = ∑ wt∗t
Duration
Modified Duration (MD) =
(1+ y )
Convexity =
∑ 2
wt∗(t +t)
2
(1+ y )
'
P −P0
% ∆ P=¿ = - MD * ∆ YTM (duration rule)
P0
P ' −P0 1 2
% ∆ P=¿ = - MD * ∆ YTM + . covexity . (∆ YTM ) (convexity rule)
P0 2

EX0: An investor is considering to invest in two stocks A and B. The historical closing prices
and dividend of the stocks are disclosed in the following tabable:
Period Price of A Dividend A Price of B Dividend of B
1 52 30
2 50 39
3 55 1.5 30 1
4 58 37
5 66 2 39 1.5
Given covariance A and B is -0.01428, Rf = 3%, return completed portfolio is 6.9%
Contrust the minium – variance portfolio and optimal risky portfolio of the two risky assets.
What is the optimized complete portfolio of two risky assets and risk-free asset.

Period rA rB
1 - -
2 -3,8% 30%
3 13% -20,5%
4 5,5% 23,3%
5 17,2% 9,5%

r 1+ r 2+r 3+r 4
Er (A) = = 7,97%
4
( r 1−r )2+ ( r 2−r )2 + ( r 3−r )2
σ 2 A=
n−1
σ A = 9,22%

Er(B) = 10,6%
σ B = 22,4 %

R(A) = Er (A) – rF = 4,97%

R(B) = Er (B) – rF = 7,6%

Min-var portfolio
σ b2−cov (a , b) 22,4 %2−(−0,01428)
wA= =
σ b2 +σ a2−2. cov (a , b) 22,4 % 2+ 9,22% 2−2.(−0,01428)
= 73,9%

wB = 26,1%

Optimal risky portfolio

2
Ra. σ b −Rb. cov (a , b)
wA = =
Ra . σ b + Rb . σ s 2−( Ra+ Rb ) . cov (a , b)
2

4,97 % .22,4 %2−7,6 % .(−0,01428)

4,97 % .22,4 %2 +7,6 % .9,22 % 2−( 4,97 %+7,6 % ) .(−0,01428)

= 72,5%

wB = 27,5%

rP = wA.rA + wB.rB = 72,5%*7,97% + 27,5%*10,6% = 8,7%

rC = wP.rP + wF.rF = 6,9%
wP + wF = 100%
=> wP = 68,4% , wF = 31,6%
 => Invest 68,4% in optimal risky portfolio and 31,6% in risk-free

EX1: A investor with a risk aversion of 2.5 is considering three financial assets,
including stock (S), long-term coupon bond (B), and a T-bill that yield a rate of 2.5%.
Expected rate of return and standard deviation of stock and bond are as follow

Expected return Standard deviation

Stock (S) 14% 18.5%

Bond (B) 6% 8.3%

Correlation between stock and bond 0.3

a/ What are the investment proportion of in the minimum-variance portfolio of the two
risky assets, and what is the expected return and standard deviation of the portfolio?

Cov (s,b) = σS . σB . p=¿ 18,5%*8,3%*0,3 = 4,6065.10^-3

σ b2−cov (s , b) 2
8,3 % −4,6065.10
−3
wS= 2 2 = = 7,15%
σ b +σ s −2.cov (s ,b) 8,3 % +18,5 % 2−2. 4,6065.10−3
2

wB = 92,85%

Er (s,b) = = 6,57%
2 2 2 2 2
σ =w S . σS +w B . σ B +2. wS . wB . σS . σB . p

= 7,15%^2*18,5%^2 + 92,85%^2*8,3%^2 + 2*7,15%*92,85%*18,5%*8,3%*0,3 =

6,7256.10^-3

σ (s ,b) = 8,2%
b/ Calculate the Sharpe ratio of the optimal risky portfolio?

Sharp ratio = (rP – rF)/ σP

Rs =14% - 2,5% = 11,5%

Rb = 6% - 2,5% = 3,5%
Rs . σ b2−Rb . cov (s , b)
wS= =
Rs . σ b 2+ Rb . σ s2−( Rs+ Rb ) . cov (s , b)
11,5 % .8,3 % 2−3,5 % . 4.6065.10−3
= 48,6%
11,5 % .8,3 %2 +3,5 % .18,5 % 2−( 11,5 %+ 3,5 % ) . 4,6065.10−3

wB = 51,4%

rP = wS.rS + wB.rB = 48,6%*14% + 51,4%*6% = 9,88%

2 2 2 2 2
σ P=w S . σS + w B . σ B +2. wS . wB . σS .σB . p

= 0,0124
σP=11,14 %

9,88 %−2,5 %
Sharp ratio = 11,14 %
=0.662

c/ Write an equation for the best feasible capital allocation line?

CAL: Er = Sharp ratio * σ + rF

Er = 0,66* σ + 2,5 %
d/ If the investor chooses to invest 45% in the optimal risky portfolio and the remainding
in a T-bill (Complete portfolio 1). Calculate the expected return and standard deviation
of the complete portfolio 1 ?

rC = wP.rP + wF.rF = 45%*9,88% + 55%*2.5% = 5,82%

σC=℘ . σP=¿45% *11,14% = 5,01%

e/ If the investor chooses to invest 70% in the minimum-variance portfolio and 30% in a
T-bill (Complete portfolio 2). Calculate the utility of the complete portfolio 2 ?

rC = wP.rP + wF.rF = 70%*6,57% + 30% * 2,5% = 5,34%

σC = wP. σP = 70%*8,2% = 5,74%

1 1
U = rC - . A σ C
2
2
= 5,34% - 2
∗2,5∗5,74 %
2
= 0,049

f/ Which complete portfolio that investor should choose?

U (C2) = 0,049

1 1
U (C1) = rC – . A σ C =¿5,82% -
2 2
∗2,5∗5,01 % =0,055
2 2

=> Choose complete portfolio 1

EX2: Price in 2013 of stock X and Y are $54 and $32 respectively. And the third is a T-
bill that yield a rate of 7%. A financial analyst of ABC Security Company forecasts the
price of stock X and Y after 1 year as following:

Period X Y

2014 52 30

2015 58 39

2016 55 32

2017 53 37

2018 64 39

a/ What are the investment proportion in the minimum-variance portfolio of the two risky
assets, and what is the expected return and standard deviation of the portfolio?

Period X Y

2014 -3,7% -6,3%

2015 11,5% 30%

2016 -5,2% -17,9%

2017 -3,6% 15,6%

2018 20,8% 5,4%

rX = 3,96%

rY = 5,36%

σX =¿10,4%

σY =¿16,7%

( X 1−X ) . ( Y 1−Y ) + ( X 2−X ) . ( Y 2−Y ) +…

Cov (x,y) =
n−1
= 0,0103

σ Y 2−cov ( x , y) 16,7 %2−0,0103

wX= = = 97,1%
σ Y 2 + σ X 2−2. cov ( x , y ) 16,7 %2 +10,4 % 2−2.0,0103

wY = 3,9%

Er (X,Y) = 97,1% * 3,96% + 3,9%*5,36% = 4,05%

cov (X , Y ) 0,0103
p= = = 0,59
σX . σY 10,4 %∗16,7 %

σ ( x , y ) =w X . σX + w Y . σ Y +2. wX . wY . σX . σY . p=¿ 0,011

2 2 2 2 2

σ (X ,Y ) = 10,5%

b/ What are the investment proportion of (S) and (B) in the optimal risky portfolio, and
what is the expected return and standard deviation of the portfolio?

Rx = rX – rF = -3,04%

Ry = rY – rF = -1,63%

2
Rx . σ y −Ry . cov ( x , y )
wX= 2 2 = 45,2%
Rx . σ y + Ry . σ a −( Rx + Ry ) . cov ( x , y )

wY = 54,8%

rP = wX.rX + wY.rY = 45,2% * 3,96% + 54,8% * 5,36% = 4,72%

σ P=w S . σS + w B . σ B +2. wS . wB . σS .σB . p = 0.01568
2 2 2 2 2

σP = 12,5%

c/ What is the Sharpe ratio of the best feasible CAL?

Sharp ratio = (rP – rF ). σP = (4,72% - 7%)/12,5% = -0,182

d/ You require that your complete portfolio yield an expected return of 16%, and that it
be efficient, on the best feasible CAL. What is the standard deviation of your portfolio?
What is the proportion invested in the T-bill fund and risky portfolio?

rC = wP.rP + wF.rF = 16%

wP + wF = 100%

=> wP = -394% ; wF = 494%

σC=℘ . σP = -394%*12,5% = - 49,25%

EX3: Bond A has 5% coupon rate, maturity is 10 years, YTM=7%

a. Find HPR for a year investment period if YTM is 6% in the end of year.
−n −10
1−( 1−r ) F 1− (1+7 % ) 1000
P 0=C . + n
¿ 50. + 10 = 859,6
r ( 1+r ) 7% ( 1+7 % )
1− (1+ 6 % )−9 1000
P1 = 50. + 9 = 932
6% (1+6 % )
P 1−P 0+ C 1 932−859,6+50
HPR = = =14,4 %
P1 859,6
b. If you sell bond after 1 year, tax on interest income is 40% and tax rate on capital gain
is 30%. The bond is subject to original issue discount tax treatment.
P0 = 859,6
P1 = 932
−n −9
1−( 1+r ) F 1−( 1+7 % ) 1000
P1’ = C . + n
=50. + 9 = 869,7
r (1+r ) 7% ( 1+7 % )
Capital gain = P1 – P1’ = 932 -869,7 = 62,3
Total interest = P1’ – P0 + C = 869,7 – 859,6 + 50 = 60,1

Taxes = 62,3*30% + 60,1*40% = 42.7

c. What is after tax holding period return on the bond?

62,3+60,1−42,7
After-tax HPR = =¿9,27%
859,6

EX4: Assume you have a 1-year investment horizon and are trying to choose among three
bonds. All have the same degree of default risk and mature in 10 years. The first is a
zero-coupon bond that pays $1,000 at maturity. The second has an 8% coupon rate pays
semi-anually. The third has a 10% coupon rate and pays once per year.
a. If all three bonds are now priced to yield 8% to maturity, what are their prices?

1000
P0 (zero-bond) = 10
=463,2
(1+8 %)

( )
−10.2
8%
−n 1− 1+
1−( 1+r ) F 80 2 1000
P0 (semi-bond) = C . + = . + =1000
( )
r (1+r )
n
2 8% 8 % 10.2
1+
2 2
−n −10
1−( 1+r ) F 1−( 1+8 % ) 1000
P0 (anually) = C . + =100. + 10 = 1134,2
r (1+r )
n
8% ( 1+ 8 % )

b. If you expect their yields to maturity to be 9% at the beginning of next year, what will
their prices be then? What is your before-tax holding-period return on each bond? If your
tax bracket is 30% on ordinary income and 20% on capital gains income, what will your
after tax rate of return be on each?
 1000−463,2
HPR (zero-bond) = =115 %
463,2

Semi – bond

( )
−9.2
9%
1− 1+
80 2 1000
P1 = . + = 963
( )
2 9% 9%
9.2
1+
2 2

( )
−9.2
8%
1− 1+
80 2 1000
P1’ = . + = 1000
( )
2 8% 8%
9.2
1+
2 2
Capital gain = 963 – 1000 = -37
Total interest = 1000 – 1000 + 80 = 80

Taxes = -37*20% + 80*30% = 16,6

Annual bond
−9
1− (1+ 9 % ) 1000
P1 = 100. + 9 = 1060
9% ( 1+ 9 % )
−9
1− (1+ 8 % ) 1000
P1’ = 100. + 9
=¿ 1124,9
8% ( 1+ 8 % )

Capital gain = 1060 – 1124,9 = -64,9

Total interest = 1124,9 – 1134,2 = -9,3

Taxes = -64,9*20% + (-9,3)*30% = -15,8

EX5:
The bond has a coupon rate of 6.4%, pays interest annually, has a face value of $1,000, 4
years to maturity, and a yield to maturity of 7.5%. You expect that interest rates will fall
by 0.3% later today.
a/ What is duration of bond ?

t CF PV wt Wt*t
1 64 59.5 6.18% 6.2%
2 64 55.4 5.75% 11.5%
3 64 51.5 5.35% 16.0%
4 1064 796.7 82.72% 330.9%

Duration = ∑ wt∗t=3,65 ( years )

P0 = 963,2

b/ Find the new price of the bond using the duration rule.
3,65
MD = =3,39
1+ 7,5 %
' '
P −P0 P −963,2
% ∆ P=¿ = - MD * ∆ YTM  =−3,39∗(−0,3 % )=¿ P' =¿ 973
P0 963,2
c/ Find the new price of the bond at its new yield to maturity. What is percentage error of
duration rule?
−4
1−( 1+ 7.2% ) 1000
P = 64. + =¿ 973,02
7.2 % ( 1+ 7.2% )
4

Error =

EX6: An investor is considering an investment to bond which has 5 years to maturity

with coupon rate is 8%, YTM= 10%
a/ Define Macaulay duration and MOD
 t CF PV wt Wt*t t^2 + t Wt*(t^2 + t)
1 80 72.7 7.87% 7.9% 2 0.16

2 80 66.1 7.15% 14.3% 6 0.43

3 80 60.1 6.50% 19.5% 12 0.78

4 80 54.6 5.91% 23.6% 20 1.18

5 1080 670.6 72.56% 362.8% 30 21.77

P0 = 924,2
Duration = ∑ wt∗t =4,28 ( years )
4,28
MD = =3,9 ( years )
1+ 10 %

b/ Define new price of the bond if interest rate decreases by 1.5%, using duration rule.
What is the percentage errors ?
' '
P −P0 P −924,2
% ∆ P=¿ = - MD * ∆ YTM  =−3,9∗(−1,5 % ) =¿ P '=¿978,27
P0 924,2
1−( 1+ 8,5 % )−5 1000
P1 = 80. + =980,3
8.5 % ( 1+ 8.5 % )
5

Error =
c/ Define convexity. Define new price of the bond if interest rate decrease by 3%, using
convexity rule. What is the percentage errors ?

Convexity =
∑ 2
wt∗(t +t)
=¿20,1
2
(1+ y )
P' −P 0 1 2
% ∆ P= =-MD*∆ YTM . covexity .( ∆ YTM ) 
P0 2
P ' −924,2 1
=−3,9∗(−1,5 % ) + .20,1 .(−1,5 %)2=¿ P’ = 980,35
924,2 2
Error =
EX7: Newly issue bond has a maturity of 5 years and pays a 7% coupon rate (with
coupon payments coming once annually). The bond sells at par value.
a/ What are the convexity and the duration of the bond?
t CF PV wt Wt*t t^2 + t Wt*(t^2 + t)
1 70 65.4 6.54% 6.5% 2 0.13

2 70 61.1 6.11% 12.2% 6 0.37

3 70 57.1 5.71% 17.1% 12 0.69

4 70 53.4 5.34% 21.4% 20 1.07

5 1070 762.9 76.29% 381.4% 30 22.89

Duration = ∑ wt∗t=¿ 4,39

4,39
MD = =4,1
1+ 7 %

Convexity=
∑ 2
wt∗(t +t )
= 20,1
2
(1+ y)
b/ Find the actual price of the bond assuming that its yield to maturity immediately
increases from 7% to 8%.
−5
1− (1+ 8 % ) 1000
P1 = 70. + 5 = 960,07
8% (1+ 8 % )
c/ What price would be predicted by the duration rule? What is the percentage error of
that rule?
P' −P 0 P ' −1000
∆ P= =-MD*∆ YTM  =−4,1∗( 1 % )
P0 1000
¿> P =¿959
'

Error =
d/ What price would be predicted by the duration-with-convexity rule? What is the
percentage error of that rule?
P' −P 0 1 2
∆ P= = -MD*∆ YTM + . covexity . ( ∆YTM )
P0 2
P ' −1000 1 2
 =−4,1∗( 1 % ) + .20,78 . (1 % ) =¿ P' =¿960
1000 2
Error =

EX8: An investor has USD 10 million and plans to invest during 2.5 years period in the
following bond portfolio.
- Bond A: Discount bond with 3 years to maturity.
- Bond B: 6% coupon bond, 2 years to maturity.
Current market interest rate is 10%. Please advise the investor to construct an appropriate
bond portfolio.

Bond A : Duration A = maturity = 3

Bond B : Duration B = 1,94

wA.DA + wB.DB = 2,5

wA + wB = 100%

=> wA = 52,8% ; wB = 47,2%