Question

Consider the following information about the shares of a large advertising company, WWPP listed on both the New York and London Stock Exchanges and a small unlisted public relations company, FAME.

Share Expected return (yearly) Risk (standard deviation)
WWPP 10% 14%
FAME 16% 28%
The correlation coefficient between the shares of WWPP and FAME is 0.7.

Estimate the risk and expected return of a portfolio comprising 40% of shares in WWPP and 60% of shares in FAME. Show your workings.

Answer 1

a). Expected Return = [W_wwpp x E(R)_wwpp] + [W_fame x E(R)_fame]

= [0.40 x 10%] + [0.60 x 16%] = 4% + 9.6% = 13.6%

b). S.D. = [(Wwwpp² x _wwpp²) + (W_fame² x _fame²) +

{2 x W_wwpp x W_fame x _wwpp x _fame x (wwpp,fame)}]^1/2

= [(0.4² x 14%²) + (0.6² x 28%²) + (2 x 0.4 x 0.6 x 14% x 28% x 0.7)]^1/2

= [31.36%² + 282.24%² + 131.71%²]^1/2 = [445.31%²]^1/2 = 21.10%