Question

1. You may invest in portfolios containing a combination of two stocks: Tech and Utility. Tech’s expected return is 20%, while Utility’s is 10%. The variance of Tech is 0.625, and the variance of Utility is 0.06. Their covariance is -0.05. What are the weights that would minimize the portfolio’s variance?

2. The way to forecast future returns on the stock market is to use the 5-year average of past

   returns. （Why is it False?)

Answer 1

Answer to Question 2. The forecast future returns on the stock market cannot be ascertained using 5-year average of past returns because the future is uncertain, so is the expected market return. The expected return of an investment is the probability weighted average of all possible returns. If the possible returns are represented by Xi and related probabilities are P(Xi), the expected return is the sum of the products of all possible returns with their respective probabilities.

Expected Return = sum (P1X1 + P2X2 + P3X3 + ..... + PnXn)