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Assignment_5

This document outlines Assignment 5 for the FINS2624 Portfolio Management course, due in Week 7. It includes three questions focusing on CAPM equilibrium, risk measures of stocks, and portfolio construction, requiring calculations of expected returns, systematic and unsystematic risks, covariances, and reward-to-risk ratios. Additionally, it mentions selected end-of-chapter questions for further study and specifies marking criteria for credit.

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19 views2 pages

Assignment_5

This document outlines Assignment 5 for the FINS2624 Portfolio Management course, due in Week 7. It includes three questions focusing on CAPM equilibrium, risk measures of stocks, and portfolio construction, requiring calculations of expected returns, systematic and unsystematic risks, covariances, and reward-to-risk ratios. Additionally, it mentions selected end-of-chapter questions for further study and specifies marking criteria for credit.

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506986561
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© © All Rights Reserved
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FINS2624: Portfolio Management

2023 Term 3

Assignment 5 due Week 7 Tutorial

Q1 Assume that the market consisting of only three stocks is in a CAPM equilibrium with a risk free rate
of 3%.

Stock Price Shares Outstanding Covariance with M

A 42 1,000 0.0657
B 40 1,200 0.0793
C 120 500 0.0406

(a) Derive the CAPM β of stocks A, B and C.

(b) The expected return on stock B, E[rB ] = 10.93. What are the expected returns on stock A, stock C, and
the market portfolio?

(c) Show that the reward-to-risk (using covariance with market as risk) ratios are in parity in a CAPM
equilibrium.

(d) Construct a portfolio which has 30% in the risk-free asset and the highest possible Sharpe ratio (i.e. which
sits on the Capital Market Line). What would be the portfolio’s expected return E[rp ], standard deviation
σp , Sharpe ratio, β, and weighting in each stock?

(e) Plot the Security Market Line, and show where stocks A, B and C sit in relation to it.

Q2 Assume that three large capitalisation stocks, Berkshire Hathaway, Apple, and Microsoft, have the
following risk measures:

Stock Beta (β) Standard Deviation

Berkshire Hathaway (BRK) 0.69 0.2350


Apple (APPL) 1.15 0.2400
Microsoft (MSFT) 1.28 0.2280

The standard deviation of the market portfolio is σM = 15.3%.

(a) Calculate the systematic and unsystematic risk of BRK, APPL and MSFT.
(b) What is BRK’s covariance and correlation with the market portfolio’s return?

(c) Estimate the following covariances: Cov(BRK, AP P L), Cov(BRK, M SF T ), and Cov(AP P L, M SF T ).
Assume all unsystematic return components are uncorrelated across stocks.

(d) Consider an equally weighted portfolio of BRK and APPL. Calculate the portfolio’s total risk (i.e. variance),
N
X
systematic risk and unsystematic risk? Verify that σP = N 2
2 1
σ2i .
i=1

(e) Consider an equally weighted portfolio of all three stocks. Calculate the portfolio’s total risk (i.e. variance),
XN
systematic risk and unsystematic risk? Verify that σ2P = N12 σ2i . What happens to unsystematic risk as
i=1
the number of assets becomes large?

Q3 Consider a market that consists of only two assets, A and B. Asset A has a weight of 0.4 (40%) in the
market portfolio and a standard deviation of 0.2 (20%). Asset B has a standard deviation of 0.5 (50%). The
correlation between the two assets is 0.3. The expected return on the market is 13%, E[rM ] = 0.13 and the
risk free rate is 3%, rf = 0.03.

(a) What is the variance of the market portfolio?

(b) What are the covariances with the market portfolio of the two assets?

(c) What are the CAPM βs of the two assets and the market portfolio?

(d) What are the reward-to-risk (use variance as risk) ratios of the two assets and the market portfolio?

(e) What are the contributions of each asset to the market excess return, E[rM ] − rf ?

(f) What are the contributions of each asset to the market variance, σM
2
?

(g) What are the contributions of each asset to the reward-to-risk ratio of the market?

(h) Suppose you had found that the contribution of asset A to reward-to- risk ratio of the market was 1 and
that the contribution of asset of B to the same ratio was 0.8. How could you construct a portfolio that beats
the market? Could this be an equilibrium?

Selected end-of-chapter questions (optional)

• BKM Chapter 8: Q8,9,10,11,12


• BKM Chapter 9: Q1-4, 9, 17-21
• BKM Chapter 10: Q1,4,5,11

Marking: To obtain the full credit, you need to attempt parts of questions 1, 2, and 3. To obtain half
credit, you need to attempt two questions from 1, 2, and 3.

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