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Assignment 7

The document outlines Assignment 7 for FINS2624: Portfolio Management, due in Week 8 Tutorial, which includes three questions focused on evaluating asset pricing, constructing optimal portfolios, and analyzing expected returns based on given data. It requires students to assess the pricing of assets X and Y, exploit mispricing, and calculate changes in Sharpe ratios. Additionally, it involves analyzing stock returns based on book-to-market ratios and capitalizations, as well as making investment decisions between two assets.

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18 views2 pages

Assignment 7

The document outlines Assignment 7 for FINS2624: Portfolio Management, due in Week 8 Tutorial, which includes three questions focused on evaluating asset pricing, constructing optimal portfolios, and analyzing expected returns based on given data. It requires students to assess the pricing of assets X and Y, exploit mispricing, and calculate changes in Sharpe ratios. Additionally, it involves analyzing stock returns based on book-to-market ratios and capitalizations, as well as making investment decisions between two assets.

Uploaded by

506986561
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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FINS2624: Portfolio Management

2023 Term 3

Assignment 7 due Week 8 Tutorial

Q1 Suppose the risk-free rate is 4% and that you believe in the estimates in the table below:

Asset E [r] σ β

X 12.5% 30% 0.5


Y 19% 50% 1.5
M 16% 20% 1.0

(a) Are assets X and Y correctly priced? If not, what are their α?

(b) Construct a portfolio that optimally exploits the mispricing.

(c) How much did the squared Sharpe ratio of your optimal risky portfolio increase when you took the
mispricing into account?

(d) How much did the Sharpe ratio of your optimal risky portfolio increase when you took the mispricing
into account?

Q2 The data in the table below was estimated using returns for the period 2001 to 2011.

rM − rf rSM B rHM L rM OM

E [r] 2.7% 5.0% 4.1% 1.3%


βM icrosof t,f actor 1.00 -0.25 -0.67 -0.15
βCoca−cola,f actor 0.60 -0.23 -0.08 0.15
βChevron,f actor 1.00 -0.46 0.33 -0.40
βGE,f actor 1.10 -0.21 0.19 -0.26

(a) What can you conclude about the return on stocks with high book-to- market ratios relative to stocks
with low book-to-market ratios? What can you conclude about the return on large capitalisation stocks
relative to small capitalisation stocks?

(b) Suppose that the risk-free rate is 3%. What is the expected return of Chevron?
Q3 You want to evaluate the stocks X and Y using the data in the table below. The risk-free rate, rf , is
3%.

Asset E [r] β σ

X 12% 1.25 30%


Y 8% 0.60 20%
M 9% 1.00 15%

(a) Suppose you’re planning to use either X or Y as your entire risky investment. Which would you choose
and why?

(b) Suppose you’re planning to use either X or Y to exploit mispricing in the market. Which would you
choose and why?

(c) Now form a new portfolio, Z, by taking a leveraged position in asset X. Specifically, invest 150% of your
wealth in asset X and finance it with an appropriate short position in the risk- free asset. What is the α of
asset Z?

Marking: To obtain the full credit, you need to attempt all parts of questions 1, 2, and 3. To obtain half
credit, you need to attempt all parts of two questions from 1, 2, and 3.

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