Problem:

Consider a portfolio consisting of two assets, A and B, with the following characteristics:

Asset A: Expected Return = 10%, Standard Deviation = 20%

Asset B: Expected Return = 12%, Standard Deviation = 25%

The correlation coefficient between Asset A and Asset B is 0.5.

The portfolio weights are as follows:

 Weight of Asset A = 0.6

 Weight of Asset B = 0.4

Question:
Calculate the expected return, the standard deviation, and the Portfolio Evaluation Index
(Sharpe Ratio) for the portfolio. Assume that the risk-free rate is 5%.

Solution:
Problem 2: Portfolio with Three Assets

Problem:
You are managing a portfolio with three assets, X, Y, and Z, with the following
characteristics:

 Asset X: Expected Return = 8%, Standard Deviation = 18%

 Asset Y: Expected Return = 10%, Standard Deviation = 22%
 Asset Z: Expected Return = 12%, Standard Deviation = 30%

The correlation coefficients are:

 Correlation between X and Y = 0.6

 Correlation between Y and Z = 0.3
 Correlation between X and Z = 0.5

The portfolio weights are:

 Weight of X = 0.4
 Weight of Y = 0.3
 Weight of Z = 0.3

The risk-free rate is 6%.

Question:
Calculate the portfolio's expected return, standard deviation, and the Sharpe Ratio.
Problem 3: Efficient Frontier Evaluation

Problem:
Given two assets, A and B, you need to evaluate the Efficient Frontier based on their returns
and standard deviations. You are interested in finding the best combination of these two
assets.

 Asset A: Expected Return = 8%, Standard Deviation = 15%

 Asset B: Expected Return = 10%, Standard Deviation = 20%
 The correlation coefficient between the two assets is 0.2.

Question:
Calculate the optimal weights for each asset that maximize the portfolio’s Sharpe ratio.
 1. A portfolio earned a return of 12% over the year.
The risk-free rate is 4%.
The standard deviation of the portfolio’s returns is 10%.

Find the Sharpe Ratio.

Sharpe Ratio= Portfolio Return−Risk-Free Rate / Standard Deviation of Portfolio Return

12%−4% =10%= 0.8

Jensen's Alpha – Problem and Solution

Problem:
A portfolio earned a return of 15%.
The risk-free rate is 5%.
The portfolio’s beta is 1.2.
The market return is 12%.

Find the Jensen’s Alpha.

Problem:
A portfolio earned a return of 14%.
The risk-free rate is 6%.
The portfolio’s beta is 1.1.

Find the Treynor Ratio.

1. Given:

 Portfolio return = 16%

 Risk-free rate = 5%
 Market return = 13%
 Portfolio beta (β) = 1.25
 Standard deviation of portfolio returns = 12%

Find:

1. Sharpe Ratio
2. Jensen’s Alpha
3. Treynor Ratio
Problem:
A portfolio earned an annual return of 18%.
In the first half of the year, the risk-free rate was 4%, and in the second half, it rose to 6%.
The standard deviation of the portfolio’s annual returns is 15%.

Find the Sharpe Ratio considering the average risk-free rate.

Problem:
A portfolio's return is 10%.
Risk-free rate = 3%.
Beta of the portfolio = 1.4.
Market return = 12%.

Find Jensen’s Alpha and comment if the portfolio manager outperformed or underperformed
the market.

Under performed.
Problem:

An investor is evaluating two portfolios:

Portfolio A Portfolio B

Expected Return 14% 12%

Standard Deviation 18% 10%

Beta 1.1 0.7

Other information:

 Risk-Free Rate = 5%
 Market Return = 13%

Tasks:

1. Find the Sharpe Ratio for both portfolios.

2. Find the Treynor Ratio for both portfolios.
3. Find Jensen’s Alpha for both portfolios.
4. Advise:
o (a) Which portfolio is better for an investor seeking maximum return per total risk?
o (b) Which is better for systematic risk optimization?
o (c) Which portfolio shows better diversification strategy based on beta?
 1. An investor is considering investing in two assets:

Stock X Stock Y
Expected Return 15% 12%
Standard Deviation 20% 15%
Beta 1.2 0.8
Correlation 0.3

Additional data:

 Risk-free rate = 5%
 Market return = 13%

Tasks:

Part A (Diversification - Markowitz):

1. Calculate the expected return and risk (σ) of a portfolio consisting of 60% in X and 40% in Y.
2. Show if diversification reduces the portfolio risk.

Part B (Risk-Return Optimization - Sharpe’s Single Index Model):

3. Use Sharpe’s Single Index concept: Find which stock offers better risk-return tradeoff (higher
excess return per unit of beta).

Part C (Performance Evaluation):

4. Calculate Sharpe Ratio, Treynor Ratio, and Jensen’s Alpha for Stock X and Stock Y.
 Diversification strategy – Markowitz’s model

Problem 1: Two-Asset Portfolio

Given:

 Asset A:
o Expected return (E₁) = 12%
o Standard deviation (σ₁) = 20%
 Asset B:
o Expected return (E₂) = 8%
o Standard deviation (σ₂) = 10%
 Correlation coefficient (ρ₁₂) = 0.3
 Weight of Asset A in portfolio = 0.4
 Weight of Asset B = 0.6

Problem 2: Finding Minimum Variance Portfolio (MVP) Weights. Efficient

frontier.

Given:

 Asset X: σ₁ = 25%
 Asset Y: σ₂ = 15%
 Correlation (ρ) = 0.2

Find: Weights for Asset X and Y to minimize portfolio variance.

Problem 3: Efficient Frontier (3 Assets)

Given:

 Asset A: E₁ = 10%, σ₁ = 18%

 Asset B: E₂ = 12%, σ₂ = 22%
 Asset C: E₃ = 14%, σ₃ = 28%
 Correlations:
o ρ₁₂ = 0.4, ρ₁₃ = 0.2, ρ₂₃ = 0.6
 Weights: A = 30%, B = 40%, C = 30%
Question:
For two assets A and B:

 Variance of A: σA2=0.04
 Variance of B: σB2=0.01
 Standard deviation of A: σA=20%
 Standard deviation of B: σB=10
 Covariance between A and B: Cov(A,B)=0.006

Find:

1. Correlation between A and B.

2. Verify covariance using correlation formula.
Question:

An investor is analysing two securities, A and B.

The data below is collected over 5 time periods (returns in decimal form):

Period Return on A Return on B

1 0.12 0.10

2 0.18 0.15

3 0.15 0.12

4 0.10 0.08

5 0.14 0.11

Compute:
1. Covariance between returns of A and B
2. Correlation between returns of A and B
 Risk and Return Optimization
Sharpe Single Index Model

Key Formulae in Sharpe’s Single Index Model:

1. Excess Return to Beta Ratio: Ri−Rf/Bi

where Ri = Expected return of asset, Rf = Risk-free rate, βi = Beta of asset

2. Total Variance=β2⋅σm2+σe2

Where:

 β: Beta of the security (systematic risk sensitivity) (how volatile/sensitive the security
is in comparison to market)
 σm2: Market variance (systematic risk component) (degree of variance of market
index return from its mean return)
 σe2: Error variance (unsystematic risk)

3. Return Computation in the Sharpe Single Index Model

Ri=Rf+βi(Rm−Rf)

1. Risk-free rate Rf=6%

Market return Rm=12%

Beta of a security β=1.5

Compute the expected return of the security.

Ans:
 3. Beta β=1.5

Market variance σm2=0.04

Error (unsystematic) variance σe2=0.02

Calculate the total risk (variance) of the security.

4. Given:

 Rf=6%
 Rm=10%
 β=0.8
 σm2=0.05
 σe2=0.03

1. Calculate expected return Ri

2. Calculate total variance (risk)

Problem 4: Moderate Beta

Given:

 Rf=7%
 Rm=12%
  β=1.0
 σm2=0.06
 σe2=0.02

5. Given:

 Rf=5%Rm=11%R_m = 11
 Expected return Ri=9.6%

Find Beta (β) of the security.

6. Given:

 β=1.1 σm2=0.06
 Total variance = 0.14

Find Unsystematic risk (σₑ²)