Question

11. Below is Megan Peters’ investment portfolio:    

       a) Calculate the expected return of her portfolio.

Stock                               % of Portfolio                           Expected Return

Cracker Barrel                         15%                                              22 %

Enterprise Rent a Car              25                                                 16

Red Roof Hotels                      10                                                 12

Cheesecake Factory                 20                                                 20

Domino’s Pizza                       30                                                 09

b) If you could only choose one, which of the following investments below would you

               choose and why?

    

     Stock                                  Return                                       Variance

      Adidas                                    10%                                            14%

      Nike                                          7%                                              5%

      Morgan Stanley                      12%                                            20%

Answer 1

11 - a

Expected return of the portfolio

where w_i = proportion of stock i in the portfolio and r_i is the expected return of the stock i

Here, n = number of stocks in portfolio = 5

Hence, expected return of the portfolio = 15% x 22% + 25% x 16% + 10% x 12% + 20% x 20% + 30% x 9% = 15.20%

11 - b

Let's evaluate the ratio = return / standard deviation.

Stock	Return	Variance	Std Dev	Return / Std dev
	R	V	S = V1/2	R / S
Adidas	10%	14%	37.42%	0.2673
Nike	7%	5%	22.36%	0.3130
Morgan Stanley	12%	20%	44.72%	0.2683

Nike has the highest return to risk ratio. It thus offers highest return per unit of risk. Hence this the best stock amongst the available lot. Hence, if we have to choose one, we will choose Nike.