P Ltd. Invested on 1.4.
2007 in Equity shares as below:
Number of
Company Cost (Rs.)
Shares
1,000
M Ltd. ₹ 200,000
(Rs. 100 each)
500
N Ltd. ₹ 150,000
(Rs. 10 each)
Dividends from M Ltd. and N Ltd. for the year ending 31.3.2008 are likely to be 20% and 35% respectively. Probabilities
of market quotations on 31.3.2008 are:
Probability Price of share Price of share
Factor of M Ltd. of N Ltd.
20.0% ₹ 220 ₹ 290
50.0% ₹ 250 ₹ 310
30.0% ₹ 280 ₹ 330
You are required to:
(i) Calculate the expected average return of each stock for the year 2007-08.
(ii) Advise P Ltd. of the comparative risk of two investments by calculating the standard deviation in each case.
Solution:
M Ltd. N Ltd.
Cost per share
Divdend
# of shares
Expected return Expected risk
M Ltd. N Ltd. M Ltd.
Probability
factor End Price Return End Price Return
20.0%
50.0%
30.0%
M Ltd. N ltd.
Expected
return
Expected risk
Co-eff of
Variation
= SD/ mean
Home Work
spectively. Probabilities
on in each case.
Expected risk
N Ltd. σ = √ ∑ {pi [(ri – E(r) ]2 }
OR...if you open the brackets
σ = √ ∑ {(pi*ri2) – E(r)2 }
The forecast of returns for securities A and B are laid out below.
Security A Security B
Probability Return (%) Probability Return (%)
0.05 15 0.05 8
0.2 20 0.25 18
0.5 25 0.4 26
0.2 30 0.25 34
0.05 35 0.05 44
Required:
(i) Expected rate of return of each security.
(ii) Standard deviation for each security.
(iii) Independent of the first three elements, assume now that the probability of return for security B will be identical with
(a) Expected return from the portfolio, if it is formed with 70% investment in A and
remainder in B.
(iv) Compute the risk in the 70/30 portfolio
Solution:
(i) Expected rate of return of each security
Security A Security B
Probability Return (%) Probability Return (%)
0.05 15 0.05 8
0.2 20 0.25 18
0.5 25 0.4 26
0.2 30 0.25 34
0.05 35 0.05 44
Expected Return
(iii-a) Expected return from the portfolio, if it is formed with 70% investment in A and remainder in B.
Weights
Probability Return in % (A) Return in % (B) Portfolio return
0.05 15 8
0.2 20 18
0.5 25 26
0.2 30 34
0.05 35 44
Asset expected
return
Portfolio expected return
(iii-C) Correlation A,B
Correlation
urn for security B will be identical with that of A. Compute
(b) covariance of AB. (c) Correlation Coefficient of AB.
(ii) Standard deviation of each security
Security A Security B
and remainder in B. (iii-b) Covariance of AB
Cov = Sum(pi*(X- ERx)*(Y-ERy))
Probability Return in % (A) Return in % (B)
0.05 15 8
0.2 20 18
0.5 25 26
0.2 30 34
0.05 35 44
Asset expected
return - E(R)
σ of Return (A)
σ of Return (B)
COV(AB)
(iii-d) Portfolio Risk
Portfolio Risk (Using COV)
Portfolio Risk (Using Correlation)
relation Coefficient of AB.
Expected Risk
The following is the return of two securities for the past five year Calculate for each the expected return and risk.
What will be expected Return of Portfolio Comprising 40% - X and 60% - Y. What will be the risk of the portfolio
Security Security Portfolio
Year
Returns- X Returns- Y Return Wx Wy
1 6.6 24.5 17.34 0.4 0.6
2 5.6 -5.9 -1.30
3 -9 19.9 8.34
4 12.6 -7.8 0.36
5 14 14.8 14.48
Weights
Expected
Return
Risk
Return of Portfolio=
Correlationof X,Y=
Risk of Portfolio=
Sqrt(Wx^2*SDx^2+Wy^2*Sdy^2+2*Wx*Wy*Sdx*Sdy*r)
turn and risk.
he portfolio
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Weights
The following is the forecast of return of two securities along with the probability of their occurrence. Calculate the expected
return and risk of both the securities. Find correlation between Returns of X & Y.
P*(X-E(X)) (Y-
Probability Return (X) Return(Y) X-E(X) Y-E(Y) P*(X-E(X))^2
E(Y))
0.05 10 18
0.2 20 12
0.5 20 28
0.2 25 28
0.05 25 38
If a portfolio comprise of 30% - X & 70% - Y, Find Expected Return, S.D. of portfolio.
Solution
Expected
Return
Risk
Corrrelation
Port. σ W1 W2
rence. Calculate the expected
P*(Y-E(Y))^2
Home Work
Mr. X is holding two securities X and Y in his portfolio. With the details given below calculate the portfolio risk and return.
Standard
Security Proportion Return
Deviation
X 0.6 10 20
Y 0.4 16 25 Home work
Correlation of the securities return is 0.50.
Soltuion
Portfolio Return
Portfolio SD
ate the portfolio risk and return.