MAF 603

PORTFOLIO MGMT & APT (RISK & RETURN)

EXERCISE 1

1. You are considering two securities in the market, Tweety and Deedee. The following table shows
their possible payoffs.

Estimated returns
State of economy Probability Tweety Deedee
Optimistic 0.2 0.2 0.35
Normal 0.7 0.3 0.3
Pessimistic 0.1 0.4 0.2

Required:

a. Determine the expected return and standard deviation of each security.

b. Calculate the covariance and correlation between the two securities.
c. Calculate the expected return and standard deviation of a portfolio that invests half of its
funds in Tweety and half in Deedee.

2. You are considering investing your money in Bursa Malaysia and decide to consider two stocks; A
and B. The table below shows relevant information related to the two stocks:

Estimated returns (%)

State of economy Probability Stock A Stock B
Recession 0.1 5 -2
Normal 0.3 12 8
Boom 0.6 18 25

Required:

a. Determine the expected return and standard deviation of each stock.

b. Calculate the covariance and correlation between the two stocks.
c. Calculate the expected return and standard deviation of a portfolio with 60% of its funds
invested in Stock A and 40% in Stock B.
d. If you could invest your money in Stock A only, or Stock B only, or the portfolio in (c) above,
which alternative would you choose? Explain your decision.