Question

1.  Your cousin Vigny is trying to take advantage of the recent changes in stock market.  However, he

      would like to invest in just two stocks, stock X and stock Y.  He calls you asking for help, he knows you    

     are a UPRRP MBA candidate.

The following information has been provided by Miguelito-Investments, Vigny’s broker:

Expected returns of X= E(RX)=20%; Expected Returns of Y=E(RY)=15%.  In addition, you find out that the expected product of the returns of RX times the return of RY, or E(RX.RY)=3%; the Standard Deviation of the returns of X=STD(RX)=29.5% and the standard deviation of the returns of Y=STD(RY)=18.20%.

Vigny has $ 2,000,000 that would like to invest, in both X and Y; 50% of that amount will go to X.  

                  a.  What return does Vigny expect to generate on this portfolio?

                  b.  What is the risk of the portfolio?

Answer 1

Portfolio	Expected Return	Weightage	Weighted return
X	20%	50%	10%
Y	15%	50%	7.500%
Expected Return from Portfolio			17.5%
Portfoilo Value	$ 2,000,000
Expected return	17.50%
Expected Return Amt	$    350,000
Portfolio	Std Dev of Return	E(RX.RY)	No of observations
X	29.50%	3%	2
Y	18.20%
Standard Measure of Risk is correlation coefficient of risk
between X& Y
Correlation coeff (XY)= Covariance (XY)/Std deviationX*Std deviationY
Covariance (XY)= E(RX.RY)/N=3%/2=1.5%
Correlation coeff (XY)=	1.5%/(29.5%*18.2%)
Correlation coeff (XY)=	27.94%
So Risk of the portfoilo=27.94%=		$     558,800