Suppose Sarah starts her investment portfolio by allocating US$ 25,000 across three assets, stocks A, B and C, as follows:

Stock A: 40% of allocation

Stock B: 32% of allocation

- At the end of the first year, Stock A returns 15.5%, Stock B returns 11% and Stock C returns 6.3%. Assuming zero trading costs, what is the total return on her portfolio?
- At the start of year 2, Sarah re-trades across three stocks, allocating the same US$ 25,000 across the same securities, as follows: Stock A allocation of 35.7% of her invested amount, Stock B allocation of 51.0%. At the end of year 2, individual assets returns are -8.0% for Stock A, 9.5% for Stock B, and 14.6% for stock C. Assuming zero trading costs, what is the total return on her new portfolio for that year?
- If Sarah did not trade at the start of year 2, what would have been her return to portfolio in year 2?

Show your work.

**Lecture 3: Q2:**

a) The risk of a portfolio consisting of two uncorrelated assets will be:

- equal to zero.
- greater than the risk of the least risky asset but less than the risk level of the more risky asset.
- greater than zero but less than the risk of the more risky asset.
- equal to the average of the risk level of the two assets.

Explain your answer

b) Assume that two assets have a coefficient of correlation of -.4. Asset A has a standard deviation of 20% and asset B has a standard deviation of 40%. Relative to holding a portfolio consisting of 100% of Asset B, what happens to risk if you combine these assets into a 50-50 weighted portfolio? Explain your answer

**Lecture 3: Q3:** Returns on the stock of FBM and MMInc for the years 2017-2020 are shown below.

FBM

MMInc

2017

-18.00%

26.00%

2018

32.00%

-5.00%

2019

18.00%

3.00%

2020

1.00%

10.00%

- Compute the average annual return for each stock and a portfolio consisting of 50% FBM and 50% MMInc.
- Compute the standard deviation for each stock and the portfolio.
- Are the stocks positively or negatively correlated and what is the effect on risk?

Explain your answers and show your work.

**Lecture 4:** **Q4:**

a) The markets in general are paying a 1% real rate of return. Inflation is expected to be 3%. RJH stock commands an 8% risk premium. What is the expected rate of return on RJH stock? Explain your answer in terms of systematic and idiosyncratic risks, and the relationship between expected (required) market returns and inflation risk.

b) The required rate of return on the RJH common stock is 10%, holding all other assumptions as in (a), what is the risk premium associated with RJH stock? Explain your answer.

**Lecture 4: Q5:** Which one following will lower required rates of return and why?

- higher rates of inflation
- higher risk premiums
- lower rates of inflation
- lower dividend yields
- higher demand for risky assets by investors
- lower risk-free rate

Explain your answers.

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