Page 93 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Security Analysis and Portfolio Management

Notes (a) What is the diversification gain from forming a portfolio that has equal proportions
of each stock?
(b) What should be the weights of the two assets in a portfolio that achieves a
diversification gain of 3%?
11. You have been asked by a client for advice in selecting a portfolio of assets based on the
following data:
Return
Year
A B C
2005 0.14 0.18 0.14

2006 0.16 0.16 0.16
2007 0.18 0.14 0.18

You have been asked to create portfolios by investing equal proportions (i.e., 50%) in each
of two different securities. No probabilities have been supplied.
(a) What is the expected return on each of these securities over the three-year period?
(b) What is the standard deviation on each security's return?
(c) What is the expected return on each portfolio?

(d) For each portfolio, how would you characterize the correlation between the returns
on its two assets?
(e) What is the standard deviation of each portfolio?

(f) Which portfolio do you recommend? Why?
12. You are considering purchasing the equity stock of B Company. The current price per
share is 10. You expect the dividend a year hence to be 1.00. You expect the price per
share of stock B a year hence to have the following probability distribution:
Price a year hence ` 10 11 12
Probability 0.4 0.4 0.2

(a) What is the expected price per share a year?
(b) What is the probability distribution of the rate of return on B's equity stock?

13. The stock of X Company performs well relative to other stocks during recessionary periods.
The stocks of Y Company, on the other hand, do well during growth periods. Both the
stocks are currently selling for 50 per share. The rupee returns (dividend plus price
change) of these for the next year would be as follows:
Economic Condition
High Growth Low Growth Stagnation Recession
Probability 0.3 0.3 0.2 0.2
Return on Wipro stock 55 50 60 70
Return on Infosys stock 75 65 50 40

Calculate the expected return and standards deviation of:
(a) 1,000 in the equity stock of Wipro.
(b) 1,000 in the equity stocks of Infosys.

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