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Problem Set 3

The document outlines a problem set for Portfolio Management focusing on portfolio optimization for Fall 2025. It includes steps for calculating monthly excess returns, means, standard deviations, correlations, alphas, betas, expected returns using CAPM, and portfolio weights for various indices. Additionally, it requires calculations for minimum variance and tangency portfolios, as well as expected returns and standard deviations for combinations of these portfolios.

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3 views1 page

Problem Set 3

The document outlines a problem set for Portfolio Management focusing on portfolio optimization for Fall 2025. It includes steps for calculating monthly excess returns, means, standard deviations, correlations, alphas, betas, expected returns using CAPM, and portfolio weights for various indices. Additionally, it requires calculations for minimum variance and tangency portfolios, as well as expected returns and standard deviations for combinations of these portfolios.

Uploaded by

nb2cxvd64h
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Portfolio Management

Problem Set 3 – Fall 2025


Johnson Mo

Q1 - Follow the steps below to generate inputs for your portfolio optimization:
a) Calculate monthly excess returns for each index. Put these numbers in the four highlighted
columns.
b) Calculate the means, standard deviations and correlations of the monthly excess returns on
the four indices. Annualize the means and standard deviations, calculate the annualized
Sharpe ratios and the annualized average total returns (using the annualized risk-free rate of
4.2% given in cell T20).
c) Calculate the alphas and betas of the US, EAFE, EM, and ACW indices relative to the ACW
index by running regressions using the monthly excess returns. Instead of using the
regression procedure built into the Analysis ToolPak, just use the =SLOPE and =INTERCEPT
functions because we do not worry about standard errors, t-stats, or R-squared for this
exercise. Also calculate the annualized alphas (multiply the monthly alpha by 12). The betas
do not need to be annualized; they should be the same regardless of the frequency of the data.
d) To get the expected total return inputs for the four indices, assume the CAPM holds with the
ACW as the market portfolio. Use the estimated beta from part c), an annualized market risk
premium equal to the average annualized excess return on the ACW index, and an annualized
risk-free rate of 4.2%. Run your calculations directly off the unrounded market risk premium
in cell T27, which is just the average excess return in R17. Do not put a rounded number in
these calculations.

Q2 - Consider the US, EAFE, and EM.


a) Calculate the unconstrained portfolio weights for the MVP and the TP using the expected
returns from Q1.d) and the historical volatilities and correlations.
b) Calculate the covariance between the MVP and the TP from part a) above. Use either the long
(9-term) formula or the short (linear algebra) version. Note that the covariance matrix will
automatically be calculated for you from the numbers you compute in Q1 and appears in the
range V17:X19. The full 4×4 matrix in V17:Y20 includes ACW and will be used below.
c) Calculate the correlation between these two portfolios.
d) Calculate expected returns and standard deviations of the portfolios on the 3-risky asset
frontier by computing these numbers for combinations of the MVP and the TP. The weight in
the minimum variance portfolio varies from −230% to 390%. If you do this correctly the IOS
will appear in the graph. Also compute the Sharpe ratio for each portfolio.

Q3 - Finally consider all four series: the US, EAFE, EM, and ACW. Compute the TP using all four
assets. Note that the variance of a four-asset portfolio is a somewhat long and messy formula.
However, if you are willing to use the linear algebra version, it is much shorter. For this latter
calculation, you need the full covariance matrix in the range V18:Y21.

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