FBIM602 TUTORIAL 4 SOLUTIONS (2017)
Question 1
P 1−P0 + D
HPR=
P0
= (220-200+8)/200 = 14%
Question 2
A) HPR
R=
( 1+ R1 ) + ( 1+ R 2 )+ ( 1+ R3 ) + ( 1+ R 4 ) + ( 1+ R5 ) −1=( 1.15 ) ( 0.95 ) ( 1.10 ) ( 1.15 ) ( 1.03 )−1=0.4235=42.35 %
B) ARITHMETIC RETURN
15−5+10+15+ 3
=7.6 %
5
C) Geometric mean
RG i =√ ( 1+ Ri 1 ) x ( 1+ Ri 2 ) x … ( 1+ Ri , T−1 ) x ( 1+ R¿ )−1
T
√5 1.15 x 0.95 x 1.10 x 1.15 x 1.03−1
=7.32%
D) To calculate the money weighted we tabulate cash-flows as follows
Year 1 2 3 4 5
Assets under management at the beginning 30 45 20 25 35
of year
Investment return for the year 15% -5% 10% 15% 3%
Investment gain (loss) 4.5 -2.25 2.00 3.75 1.05
Total assets before net inflows 34.5 42.75 22.00 28.75 36.05
New investment (cash inflow for the fund) 10.5 0 3.00 6.25 0
Withdrawal by the investor (cash outflow 0 22.75 0 0 0
for the fund)
Assets under management at end of year 45 20 25 35 36.05
( CF 0=−30 , CF 1=−10.50 , CF 2 =+ 22.75 ,CF 3=−3.00 , CF 4 =−6.25 . CF 5=+36.05 )
NB) each cash flow or outflow occurs at the end of each yea. Thus CF 0refers to cash flow at
the end of year zero or beginning of year 1. And CF5 refers to the cash flow at the end of year
5 or beginning of year 6. Because cash flows are being are being discounted to the present-
that is, end of year 0 or beginning of year 1 -the period of discounting Cf0 is zero whereas the
period of discounting for CF5 is 5 years.
To get the IRR, the following equation will be equated to zero. Instead however we use 5%
return to whether the value of the expression is positive or not. If it is positive, then the
money weighted rate of return in greater than 5% because the 5% discount rate could not
reduce the value to zero
−30.00 −10.50 −22.75 −3.00 −6.25 36.05
0
+ 1
+ 2
+ 3
+ 4
+ 5
=1.1471
(1.05) (1.05) (1.05) (1.05) (1.05) (1.05)
Using a financial calculator, the exact money- weighted rate of return is 5.86%
Question 3
Solution
a) 12=(w1x19%) + ( 1-w1)x8%; W1 = 36.4 1-W1= 63.4% thus 36.4 in the small cap and 63.4
in the bond.
b) √ ¿ ¿ ¿
Question 4
Negatively correlated securities returns offset each other. Losses in one security are covered by profits
from the other security. The stronger the negative relation the highly diversified the portfolio is.
Question 5.1
Return Return
Prob Pi*C Pi*D A*(B-7,6)^2 A*(C-2,9)^2
on C on D
0,1 -0,17 -0,4 -0,017 -0,04 0,0060516 0,0184041
0,1 -0,03 -0,02 -0,003 -0,002 0,0011236 0,0002401
0,2 0,08 0,14 0,016 0,028 3,2E-06 0,0024642
0,2 0,17 0,25 0,034 0,05 0,0017672 0,0097682
0,3 0,14 -0,05 0,042 -0,015 0,0012288 0,0018723
0,1 0,04 0,08 0,004 0,008 0,0001296 0,0002601
expected
return 0,076 0,029 0,010304 0,033009
SD 0,10150862 0,181683791
Expected return of C = (0.1*-0.17) +(0.1*-0.03) + (0.2*0.08) +(0.2*0.17) + (0.3*0.14) +
(0.1*0.04)=0.076
Expected return of D = (0.1*-0.04) +(0.1*-0.02) + (0.2*0.14) +(0.2*0.25) + (0.3*-0.05) +
(0.1*0.08)=0.029
Var C= (0.1*(-0.17-0.076) +(0.1*(-0.03-0.076) + (0.2*(0.08-0.076) +(0.2*(0.17-0.076) + (0.3*(0.14-
0.076) + (0.1*(0.04-0.076) = 0,010304
Standard deviation = (0,010304) ^ (1/2) = 0,1015
Var D= 0.1*(-0.04-0.029) ^2+(0.1*(-0.02-0.029) ^2 + (0.2*(0.14-0.029) ^2 +(0.2*(0.25-0.029) ^2 +
(0.3*(-0.05-0.029)^2 + (0.1*(0.08-0.029)^2=0,033009
Standard deviation = (0,033009) ^ (1/2) = 0,1816
Coefficient of variation = standard dev/mean C = 0.101509/0.076=1.34
D=0.181684/0.029 = 6.26
Security C high return, low risk based on the CV ….
5.2. Covariance =0.1(-0.17-0.076) (-0.4-0.029)+0.1(-0.03-0.076)(-0.02-0.029) +0.2(0.08-0.076)(0.14-
0.029)+0.2(0.17-0.076)(0.25-0.029)+0.3(0.14-0.076)(-0.05-0.029)+0.1(0.04-0.076)(0.08-0.029) =
0,013616
Correlation = 0.013616/(0.1015 x 0.1816) = 0.73
Therefore both assets are positively correlated
Question 6
6.1. Rrr (M) = 0.11+1.2(0.05)=0.17
Rrr (N) = 0.11+1.4(0.005)=0.18
6.2. (0.55*0.17) + (0.45*0.18) = 0.1745
6.3. Alpha= 0.3-0.108=0.192 – alpha is positive security M is undervalued hence buy
Question 7
a) risk averse investor more weight in the less risk asset.
b) Expected return of the portfolio = (0.7*0.1) +(0.3*0.12) =0.106
variance of the portfolio
0.7^2*0.04^2+0.3^2*0.07^2+2*0.7*0.3*0.04*0.07*-0.10=00.0011074
Standard dev =0.033
c.) Expected return = (0.06*0.3) +(0.1*0.7) = 0.08=8%
standard deviation = (0.7) ^2*(0.04) ^2=0.4916^ (0.5)=0.028
d.) the return of the portfolio with the risk free is lower than the portfolio with risky assets. The
portfolio with a rf assets has a lower risk than the one risky assets.
Higher risk higher returns.
Question 8
a) Mean = (0.30 x 7%) + (0.7 x 17%) = 14% per year.
Standard deviation = 0.70 x 27% = 18.9% per year.
b) (a) Mean return on portfolio = Rf + (Rp - Rf)y
= 7% + (17% - 7%)y = 7% + 10%y
If the mean of the portfolio is equal to 15%, then solving for y we will get:
15% = 7% +10%y => y = (15% - 7%)/10% => y = 0.8
Thus, in order to obtain a mean return of 15%, the client must invest 80% of total funds in the risky
portfolio and 20% in Treasure bills.
(b) Investment proportions of the client’s funds:
• 20% in T-bills
• 0.8 x 27% = 21.6% in Stock A
• 0.8 x 33% = 26.4% in Stock B
• 0.8 x 40% = 32.0% in Stock C
9. a) E ( R A )=9.9 % √
E ( R B )=17.7 % √
σ 2A=( 0.3 × ( 15−9.9 )2 ) + ( 0.5× ( 10−9.9 )2 ) + ( 0.2 × ( 2−9.9 )2 ) √ m=20.29 √
σ A=4.5 % √
σ 2B=( 0.3 × ( 25−17.7 )2 ) + ( 0.5 × ( 20−17.7 )2 ) + ( 0.2× (1−17.7 )2 ) √ m=74.4 √
σ B=8.63 % √
Share B √ has the highest level of total risk since its standard deviation is larger than that of
A.
b) E ( R M )=12.7 % √
σ 2M =( 0.3 × ( 16−12.7 )2 ) + ( 0.5 × ( 13−12.7 )2 ) + ( 0.2 × (7−12.7 )2) √ m=9.81 √
σ M =3.13 %
cov ( A , M )=[ 0.3 × ( 15−9.9 ) ( 16−12.7 ) ] + [ 0.5 × ( 10−9.9 ) ( 13−12.7 ) ] + [ 0.2× ( 2−9.9 )( 7−12.7 ) ] √ m=14.
14.07
β A= =1.43 √
9.81
cov ( B , M )= [ 0.3× ( 25−17.7 ) (16−12.7 ) ] + [ 0.5× ( 20−17.7 ) (13−12.7 ) ] + [ 0.2 × (1−17.7 ) ( 7−12.7 ) ] √ m=
26.61
βB= =2.71 √
9.81
Share B √ has the highest level of systematic risk, since its beta is higher than that of A
c) ER(A) = 4 + 1.43(12.7-4) = 16.44%
ER(B) = 4 + 2.71(12.7-4) = 27.58%
