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Essentials of Investments: Chapter 5 - Risk and Return Past and Prologue

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Essentials of Investments: Chapter 5 - Risk and Return Past and Prologue includes Rates of Return, Returns Using Arithmetic and Geometric Averaging, Dollar Weighted Returns, Dollar Weighted Average Using Text, Quoting Conventions.

ill Companies, Inc All rights reserved 34 Bodie • Kane • Marcus Essentials of Investments Problem 14: Reward to Variability Fourth Edition C What is the reward-to-variability ratio (s) of your risky portfolio and your clients portfolio? – Reward to Variability (risk premium / standard deviation) – – Fund = (12.0% – 4%) / 25 = 32 Client = (9.6% – 4%) / 17.5 = 32 Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 35 Bodie • Kane • Marcus Essentials of Investments Problem 15: The CAL Line Fourth Edition D Draw the CAL of your portfolio What is the slope of the CAL? Slope of the CAL line % 17 14 Slope = 3704 P Client Standard Deviation Irwin / McGraw-Hill 18.9 27 © 2001 The McGraw-Hill Companies, Inc All rights reserved 36 Bodie • Kane • Marcus Essentials of Investments Problem 16: Maximizing Standard Deviation Fourth Edition Suppose the client in Problem 12 prefers to invest in your portfolio a proportion (y) that maximizes the expected return on the overall portfolio subject to the constraint that the overall portfolio’s standard deviation will not exceed 20% What is the investment proportion? What is the expected return on the portfolio? Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 37 Bodie • Kane • Marcus Answer Essentials of Investments Fourth Edition Portfolio standard deviation 20% = (y) x 25% Y = 20/25 = 80.0% Mean return = (.80 x 12%) + (.20 x 4%) = 10.4% Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 38 Bodie • Kane • Marcus Essentials of Investments Problem 17: Increasing Stock Volatility Fourth Edition • What you think would happen to the expected return on stocks if investors perceived an increased volatility of stocks due to some recent event, i.e Hurricane Katrina? Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 39 Bodie • Kane • Marcus Answer Essentials of Investments Fourth Edition • Assuming no change in risk aversion, investors perceiving higher risk will demand a higher risk premium to hold the same portfolio they held before If we assume the risk-free rate is unchanged, the increase in the risk premium would require a higher expected rate of return in the equity market Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved Review of Objectives • A Do you understand rates of return? • B Do you know how to calculate return using scenario, probabilities, and other key statistics used to describe your portfolio? • C Do you understand the implications of using a risky and a riskfree asset in a portfolio? ...34 Bodie • Kane • Marcus Essentials of Investments Problem 14: Reward to Variability Fourth Edition C What is the reward-to-variability ratio (s) of your risky portfolio and your clients portfolio?... Variability (risk premium / standard deviation) – – Fund = (12.0% – 4%) / 25 = 32 Client = (9.6% – 4%) / 17 .5 = 32 Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 35 Bodie... Marcus Essentials of Investments Problem 15: The CAL Line Fourth Edition D Draw the CAL of your portfolio What is the slope of the CAL? Slope of the CAL line % 17 14 Slope = 3704 P Client Standard

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