Mr Watson has savings of £12,000. Of this amount he has invested £6,000 in Treasury Bills which currently yield a return of 6%. The remainder has been invested in a portfolio of four different companies’ shares. Details of this portfolio are as follows:
Company |
Expected Return |
b shares |
Worth of share holding |
W |
7.6% |
0.20 |
£1,200 |
X |
12.4% |
0.80 |
£1,200 |
Y |
15.6% |
1.20 |
£1,200 |
Z |
18.8% |
1.60 |
£2,400 |
i).
Given the value of holdings in the portfolio as 1200,1200,1200,2400 for the 4 stocks in the portfolio, which gives a cumulative sum of 6000. So, we can arrive at individual weights as 1200/6000= 0.2 and 2400/6000= 0.4. So, Individual weights of the stocks are 0.2,0.2,0.2 and 0.4
Expected return of a portfolio is calculated as the weighted average of individual expected returns. So, Expected return of the portfolio= (0.2*7.60%)+(0.2*12.40%)+(0.2*15.60%)+(0.4*18.80%)= 14.64%
Beta of a portfolio is also calculated as weighted average of individual Betas. So, Beta of the portfolio= (0.2*0.2)+(0.2*0.8)+(0.2*1.2)+(0.4*1.6)= 1.08
ii).
Watson is getting 6% on Treasury bills in which he invested a total amount of 6000 and remaining 6000 in the portfolio, whose return we calculated as 14.64%.
So, total return of his savings portfolio is (0.5*6%)+(0.5*14.64%)= 10.32%
He wants an expected return of 12% on his portfolio, by investing some proceeds from Treasury bills to market portfolio. The return on market portfolio is 14%. This is calculated using CAPM model for a stock in the portfolio. For Company W, 7.6%= 6%+(0.2*Rm-6%). Which gives Rm= 14%.
Let the weights on Treasury bills and market portfolio be x and y. So, we have (x*6%)+(50%*14.64%)+(y*14%)= 12% and x+y should be equal to 1.
On solving these two equations, we get x= 29% and y= 21%
So, he can achieve the desired returm of 12% by selling 21% (50%-29%) of Treasury bills and investing the proceeds in market portfolio.
iii).
If Mr.Watson can invest in only Treasury bills and Market portfolio, his expected return would be (x*6%)+(y*14%), assuming x and y are weights of both respectively.
Given the expected return should be 10.32%.
So, (x*6%)+(y*14%)= 10.32% and x+y=1
So, 0.06x+(1-x)*0.14= 0.1032
= -0.08x= -0.0368
So, x= 46%.
So, To achieve 10.32%, His savings portfolio should be 46% of Treasury Bills and 54% of Market portfolio
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