Financial Investments

Chapter 4 - Part I

Nelson Areal
Management Department
Exercise 5 - (BKM - 2022: Chapter 5)
Suppose your expectations regarding the stock market are as
follows:

State of the
Probability HPR
economy
Boom 0.3 44%
Normal Growth 0.4 14%
Recession 0.3 -16%

Compute the mean and standard deviation of the HPR on stocks.

Exercise 7 - (BKM - 2022: Chapter 5)
XYZ stock price and dividend history is as follows:

Price at the Dividend paid at

Year
beginning of the year-end
2018 year
$100 $4
2019 $110 $4
2020 $90 $4
2021 $95 $4

An investor buys three shares of XYZ at the beginning of 2018,

buys another two shares at the beginning of 2019, sells one
share at the beginning of 2020 and sells all four remaining
shares at the beginning of 2021.
a. What are the arithmetic and geometric average time-weighted
rates of return for the investment?
b. What is the dollar-weighted rate of return?
Exercise 11 - (BKM - 2022: Chapter 5)

Consider a risky portfolio. The end-of-year cash ow derived

from the portfolio will be either $50 000 or $150 000, with
equal probabilities of 0.5. The alternative riskless investment in
T-bills pays 5%.
a. If you require a risk premium of 10%, how much will you be
willing to pay for the portfolio?
b. Suppose the portfolio can be purchased for the amount you
found in (a). What will the expected rate of return on the
portfolio be?
c. Now suppose you require a risk premium of 15%. What is
the price you will be willing to pay now?
d. Comparing your answers to a) and c) what do you conclude
about the relationship between the required risk premium on a
portfolio and the price at which the portfolio will sell?

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Exercise 12 - (BKM - 2022: Chapter 5)
Assume that you manage a risky portfolio with an expected
rate of return of 17% and a standard deviation of 27%. The
T-bill rate is 7%.
a. Your client chooses to invest 70% of a portfolio in your
fund and 30% in a T-bill money market fund. What is the
expected return and standard deviation of your client’s
portfolio?
b. Suppose your risky portfolio includes the following
investments in the given proportions:
Stock A 27%
Stock B 33%
Stock C 40%

What are the investment proportions of your client’s

overall portfolio, including the positions in T-bills?
Exercise 12 - (BKM - 2022: Chapter 5)

...continuation

c. What is the Sharpe ratio (S) of your portfolio and your

client’s overall portfolio?
d. Draw the CAL of your portfolio on an expected return/
standard deviation diagram. What is the slope of the CAL?
Show the position of your client on your fund’s CAL.
Exercise 13 - (BKM - 2022: Chapter 5)

Suppose the same client in the previous problem decides to

invest in your risky portfolio a proportion (y) of his total
investment budget so that his overall portfolio will have an
expected rate of return of 15%?
a. What is the proportion y?
b. What are your client’s investment proportions in your
three stocks and the T-bills?
c. What is the standard deviation of the rate of return on
your clients portfolio?
Exercise 8 - (BKM - 2022: Chapter 5)

a. Suppose you forecast that the standard deviation of the market

return will be 20% in the coming year. If the measure of risk
aversion in Equation 5.16 is A = 4, what would be a reasonable
guess for the expected market risk premium?

Average(rM ) rf
Ā = 2
Sample M
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b. What value of Ā is consistent with a risk premium of 9%?

c. What will happen to the risk premium if investors become more

risk tolerant?
Exercise

Go to http:// nance.yahoo.com and download the data

for AAPL over the period of 01-01-2021 to 01-03-2023
(daily frequency).

a. Compute the daily returns using the Adjusted Price.

b. Compute the average daily return over the period.
c. Compute the standard deviation of the daily return.
d. Compute the skewness of the daily returns.
e. Compute the kurtosis of the daily returns.
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