FINS2624(Portfolio Management)
Kai Lin(z3411977)
2Question1:
a). U(W)=W^2: According to the utility function, the investors utility grows with his
gain in wealth and vice versa, hence intuitively this is likely to represent the investors
preference.
b). U(W)=1/W: According to the utility function, the investors utility decreases with
his gain in wealth, and his utility is infinity when he has almost zero wealth, hence
intuitively this is unlikely to represent the investors preference.
c). U(W)=-W: According to the utility function, the investors utility decreases with his
gain in wealth, hence intuitively this is unlikely to represent the investors preference.
d). U(W)=W: According to the utility function, the investors utility grows with his gain
in wealth and vice versa, hence intuitively this is likely to represent the investors
preference.
e). U(W)=ln(W): According to the utility function, the investors utility grows with his
gain in wealth and vice versa, hence intuitively this is likely to represent the investors
preference.
f). U(W)=-1/W: According to the utility function, the investors utility grows with his
gain in wealth and vice versa. However, the utility of this investor is always negative
which is unlikely to represent the investors preference.
Among those utility functions likely presenting the investor preferences, U(W)=W is
the mostly likely because it has reasonable increase in the utility due to the increase
in wealth, whereas U(W)=W^2 increases too fast and U(W)=ln(W) increases too
slowly.
Question2:
1
U=E ( r ) A 2
2
1
U A =0.2 A ( 0.22 ) =0.20.02 A=0.18
2
1
2
Portfolio B: U B =0.12 A ( 0.22 ) =0.120.0242 A=0.0958
2
1
2
Portfolio C: U C =0.15 A ( 0.28 ) =0.150.0392 A=0.1108
2
a) As long as A is positive, every investors are going to pick portfolio A because it has
the highest expected return and lowest standard deviation. However if the A is
negative then the answer depends on the value of A.
b) If risk aversion A equals 1, the utility function value for each portfolio is calculated
as in the above.
1
1
2
2
c): U B =0.12 A ( 0.22 ) =U C =0.15 A ( 0.28 ) if B&C is indifferent. Then A is calculated to
2
2
be 2.
Portfolio A:
1
1
1
Question3: The portfolio has this numerical expression r P = r A + r B + r C
3
3
3
1
E ( r A ) + E ( r B ) + E ( r C )= ( 12 + 17 +7 )=12
3
a)
1
1
1
1
E ( r P )=E r A + r B + r C =
3
3
3
3
21
21
21
1
1
1
2
2
2
1
1
1
1 2
3
1 2
3
1 2
3
2
P=var r A + r B + r C =
A+
AB A B +
B+
BC B C +
C +
AC A C =0.0
3
3
3
3
3
3
3
3
3
Hence P=19.3 .
b). The diversification benefit of the investor shifting from asset A, will be reduced
)()
()
()
FINS2624(Portfolio Management)
Kai Lin(z3411977)
standard deviation at the same expected return. From asset B, the benefit will be
significantly reduced standard deviation at a relatively small reduction in the expected
return. From asset C, the benefit will be improved expected return and a minor
reduction in standard deviation.
c),d) the answer should be chosen based on a given utility function for the specific
investor, otherwise A represents an indicator of investors risk aversion, the higher the
value of A is ,the more risk averse the investor is, hence if A=3 the investor is likely to
chose the equally weighted portfolio over asset 2, if A=1 the investor is likely to chose
asset 2 over the portfolio.
e).
1
1
1
r P 1= r A + r B + r C
3
3
3
1
1
r P 2= r A + r C
2
2
1
1
1
1
1
1
Cov ( r P 1 , r P 2 )=Cov r A + r B + r C , r A + r C = [ Cov ( r A , r A ) + Cov ( r A , r B ) +2Cov ( r A , r C ) +Cov ( r C , r B ) +Cov ( r C
3
3
3
2
2
6
1
[ Var ( r A ) + Cov ( r A , r B ) +2Cov ( r A , r C ) +Cov ( r C , r B ) +Var ( r C ) ]
6
1
2
[ 0.25 +[Link]+[Link]+[Link]+0.22 ]=0.031
6
Question5:
( 12 r + 12 r )= 12 ( E (r )+ E ( r ) )= 12 ( 14.71 +16.12 )=15.415
1
1
1
1
E ( r ) =E ( r + r + r )= ( 18.99 + 24.01 +21.17 )=21.39
3
3
3
3
a). E ( r P )=E
b).
Cov ( r P ,r Q )=Cov
Question4:
( 13 r + 13 r + 13 r , 12 r + 12 r )= 16 [ Cov (r , r )+Cov (r , r )+Cov ( r , r )+Cov ( r , r )+Cov ( r , r )
X