Portfolio Management Theory and Applications.
Research Project – Additional questions. Please submit it before the final exam throough email.
3. Anne Grace has 3 $900 000 fully diversified pontolio. She subsequently inherits ABC Company common stock
worth $100 000- Her financial adviser provided her with the following estimates:
Risk and return characteristics
Expected monthly returns % Standard deviation of monthly returns S“.
Original portfolio ot67 2-37
ABC Company 125 2.95
The correlation coefficient of the ABC stock returns with the original portfolio returns is 0.40.
a. The inheritance changes Grace’s overall portfolio and she is deciding whether to keep the ABC stock. Asswmg
Grace keeps the ABC stock. calculate the:
i. expected return of her new portfolio which includes the ABC stock.
covariance of ABC stock returns with the original portfolio returns.
iii. standard deviation of her new portfolio which includes the ABC stock.
b. if Grace sells the ABC stock. she will invest the proceeds in risk-free government secwities yielding 0.42%
monthly. Assuming Grace sells the ABC stock and replaces it with the government securities. calculate the:
i. expected return of her new portfolio which includes the government securities.
ii. covariance of the government security returns with the original portfolio returns.
iii. standard deviation of her new portfolio which includes the government securities.
c. Determine whether the beta of her new portfolio, which includes the government securities, will be higher or
lower than the beta of her Original portfolio.
(1. Based on conversations with her husband. Grace is oonsidering selling the $100 000 of ABC stock and acquiring
$100 000 of XYZ Company commOn stock instead. XYZ stock has the same expected return and standard
deviation as ABC stock. Her husband comments. ‘It doesn’t matter whether you keep all of the ABC stock or
replace it with $100 000 of XYZ stock’. State whether her husband’s comment is correct or inCOrrect. Justify your
e. In a recent discussion with her financial adviser. Grace commented. ‘lf ljust don‘t lose money in my portfolio. I will
be satisfied’. She went on to say. ‘I am more afraid of losing money than I am concerned about achieving high
retums’. Descn’be one weakness of using standard deviation of returns as a risk measwe for Grace. to 6.3
16. Your assistant gives you the following diagram as the efficient frontier of the group of shares you ask him to
analyse. The diagram looks a bit odd. but your assistant insists he double-checked his anainis. Will you believe
him? is it possible to get such a diagram? Lo 6.6