Question

Risk and return

You are considering an investment in the stock market and have identified three potential stocks, they are Crown (ASX: CWN), Tencent (HKG: 0700) and Commonwealth Bank (ASX: CBA).  The historical prices for the past 10 years are shown in the table below.  Assume no dividend is distributed during this period.

Year	Crown	Tencent	Commonwealth (CBA)
2010	7.76	29.04	53.63
2011	8.57	40.40	52.15
2012	8.09	37.94	50.39
2013	11.59	54.28	64.10
2014	16.68	108.70	73.83
2015	13.61	132	88.85
2016	12.27	144.90	78.67
2017	11.4	204.40	81.66
2018	13.25	463.60	78.87
2019	11.95	346	69.91

Calculate the return and risk (standard deviation) of each stock.  

Explain the relation (positive or negative) between risk and return based on your answers in part (1).

Calculate the correlation coefficient between (a) Crown and Tencent and (b) Tencent and CBA.  

Calculate the expected (annual) return and standard deviation if you owned a portfolio consisting of 50% in Crown and 50% in Tencent.

Calculate the expected (annual) return and standard deviation if you owned a portfolio consisting of 40% in CBA and 60% in Tencent.

Which portfolio (parts 4 or 5) provides better diversification? Explain your answer(s).

Answer 1

Solution in Excel:

Year	Crown	Tencent	Commonwealth (CBA)
2010	7.76	29.04	53.63
2011	8.57	40.4	52.15
2012	8.09	37.94	50.39
2013	11.59	54.28	64.1
2014	16.68	108.7	73.83
2015	13.61	132	88.85
2016	12.27	144.9	78.67
2017	11.4	204.4	81.66
2018	13.25	463.6	78.87
2019	11.95	346	69.91
Return	11.52	156.13	69.21
Risk	2.78	145.21	13.58
Return/Risk	4.15	1.08	5.10

Formulas Used: