Consider the following information on a portfolio of three stocks: Required: If

Question

Consider the following information on a portfolio of three stocks: Required: If your portfolio is invested 44 percent each in A and B and 12 percent in C, what is the portfolio's expected return, the variance, and the standard deviation? (Do not round intermediate calculations. Round your variance answer to 5 decimal places (e.g., 32.16161) and input your other answers as a percentage rounded to 2 decimal places (e.g., 32.16).) If the expected T-bill rate is 3.95 percent, what is the expected risk premium on the portfolio? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Explanation / Answer

Solution Return (R Probability (P) Expected Return (R*P) A B C A B C 6 36 56 0.15 0.90 5.40 8.40 14 16 24 0.51 7.14 8.16 12.24 20 -15 -39 0.34 6.80 -5.10 -13.26 (a) 14.84 8.46 7.38 Weight (w) 0.44 0.44 0.12 (a*w) 6.53 3.72 0.89 Expected return (6.53+3.72+0.89) = 11.14% Standard deviation of portfolio Expected return Deviation (R - 11.14) Deviation Square Probility Variance A 14.84 3.7 13.69 0.15 2.05 B 8.46 -2.68 7.18 0.51 3.66 C 7.38 -3.76 14.14 0.34 4.81 10.52 Standard deviation of portfolio = Variance 10.52 3.24 So Expected return is 11.14%, Variance is 10.52 and Standard deviation is 3.24 (b) Risk Premium = (Rm- Rf) (11.14-3.95) Where Rm = Return on market portfolio 7.19% Rf= Risk free rate of return (T-Bill rate)

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