FINM7006: Applied Foundations of Finance
Tutorial 6 Questions
Question One
Comment on the accuracy of the following statement: “Two assets that have the same
expected return and same variance cannot provide diversification benefits if combined
in a two-asset portfolio”.
Question Two
Suppose Assets A and B have the following expected returns and standard deviations:
Asset Expected Return (E(R)) Standard Deviation
()
A 15% 9%
B 11% 6%
a) Calculate the expected return and standard deviation for a portfolio with 30%
in A and 70% in B given that the assets have a correlation of 0.65.
b) Has diversification reduced the risk of the portfolio?
Question Three
Suppose assets C and D have expected returns and standard deviations as follows:
Asset Expected Return Standard
(E(R)) Deviation
C 12% ()
10%
D 8% 8%
The returns of the two securities have a correlation of 0.5. What is the expected return
and standard deviation of a portfolio with equal weights in each security? What is the
composition of the minimum variance portfolio and what is the expected return and
standard deviation of this portfolio?
Question Four
Suppose I have a portfolio comprising only two assets: E and F. The expected return
on this portfolio is 9.5%. Calculate the portfolio weights given the expected returns on
Assets E and F are 10% and 8% respectively.
Question Five
Calculate the covariance of a portfolio comprising equal weights of assets G and H
given the assets have standard deviations of 15% and 18% respectively and the assets
are perfectly negatively correlated.
1
FINM7006: Applied Foundations of Finance
Question Six
Your portfolio currently consists of only one stock that has an expected return of 8%
and a standard deviation of 21%. A friend has advised you that you would be able to
get the same return at much lower risk if you instead invested in a portfolio consisting
of PBL shares and a 10 Year Government Bond. Their expected returns and standard
deviations are as follows:
Security E(R)
PBL 12% 29%
10 Year Bond 7% 10%
The correlation between PBL shares and the 10 Year Government Bond is 0.15.
Would a portfolio of PBL and the 10 Year Government Bond give the same return as
your existing portfolio? If so, what is the composition and standard deviation of this
new portfolio? Is your friend correct?
Question Seven
Suppose perfectly positively correlated assets 1 and 2 have the following expected
returns and standard deviations:
Asset E(R)
1 12% 9%
2 10% 6%
a) Calculate the expected return and standard deviation for a portfolio comprising
equal weights of 1 and 2.
b) What is the composition of the minimum variance portfolio and what is the
expected return and standard deviation of this portfolio?
c) Has risk been reduced (due to diversification) with respect to the minimum
variance portfolio? Explain your answer.