Explain expected returns and risk in portfolio.
1) You friend John has discovered two Apex and Bull and recommended to you. Utilizing the historical data John has estimated the means and volatilities and correlation of the two stocks as the following
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Stock A
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Stock B
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Means
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0.15
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0.09
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St. Dev.
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0.32
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0.23
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Correlation among the two stocks is 0.15. Presume that the risk-free rate is 5.50%.
1) Without taking this class John merely split his investment equally in the two stocks. Explain what is the expect return and volatility of his portfolio?
2) Explain what is the Sharpe ratio of John's portfolio?
3) One thing you have learned is that the tangency portfolio will give you the maximum Sharpe ratio. Therefore, you have constructed such a portfolio. What are you portfolio weights?
4) Explain what your portfolio's Sharpe ratio is and how much can you gain?
2. Continue from the above question.
1) Since John does not understand the concept of Sharpe ratio, you construct a BEST portfolio that yields the same return as that of John. What are the portfolio weights? (Hint- use the risk-free asset too)
2) Explain what is the volatility of your portfolio, and how much volatility can you cut relative that of John?
3) Explain what is your allocation in the three assets-Stock A, Stock B and the Risk-free?