Question

1. Ruby decides to invest $300,000 in stock A, $250,000 in stock B, $150,000 in stock C and $100,000 in stock D. She has forecasted the possible returns for all four stocks, which will vary according to the state of the economy. The projections are as follows:

Economy	R i,A (%)	Ri,B (%)	Ri,C (%)	Ri,D (%)	Probability (%)
Boom	21	9	18	25	25
Normal	10	18	14	15	35
Recession	-5	3	-4	8	40

Calculate the expected return of Ruby’s portfolio.

1. FX dealer Christopher provides a quote of AUD/USD 0.8025-27. Explain what this quote means.

2. A Japanese firm needs New Zealand dollars to buy New Zealand goods. It would like to find out the New Zealand dollar value relative to the Japanese Yen (JPY/NZD). The only quotes available are as follow:

NZD/AUD= 1.084

JPY/AUD = 77.24

What is the exchange rate for JPY/NZD?

3. How is a simple interest rate agreement different to a compound interest rate agreement? Give examples.

Answer 1

Expected return of stock = (probability of boom scenario * expected return in boom scenario) + (probability of normal scenario * expected return in normal scenario) + (probability of recession scenario * expected return in recession scenario)

Expected return of stock A = (25% * 21%) + (35% * 10%) + (40% * -5%) = 7%

Expected return of stock B = (25% * 9%) + (35% * 18%) + (40% * 3%) = 10%

Expected return of stock C = (25% * 18%) + (35% * 14%) + (40% * -4%) = 8%

Expected return of stock D = (25% * 25%) + (35% * 15%) + (40% * 8%) = 15%

Expected return of portfolio = (300000 / 800000) * 7% + (250000 / 800000) * 10% + (150000 / 800000) * 8% + (100000 / 800000) * 15% = 3% + 3% + 1% + 2% = 9%