Problem Set: Risk and Return

(Solutions Below)
Expected Rate of Return
1. Find the expected rate of return:
Probability
20%
30%
30%
20%

Return
-24%
0
5%
25%

2. Find the expected rate of return:

Probability
10%
20%
50%
20%

Return
-10%
-5%
15%
10%

3. Find the expected rate of return:

Probability
10%
30%
40%
20%

Return
-4%
0
15%
20%

Standard Deviation
4. Find the variance and standard deviation:
Probability
20%
30%
30%
20%

Return
-24%
0
5%
25%

5. Find the variance and standard deviation:

Probability
10%
20%
50%
20%

Return
-10%
-5%
15%
10%

6. Find the variance and standard deviation:

Probability
10%
30%
40%
20%

Return
-4%
0
15%
20%

Two-Asset Portfolios
7. Find the expected return, variance and standard deviation of the
two-asset portfolio:
Asset
A
B

Return
14%
12%

Standard Deviation
20%
15%

Weight
20%
80%

Correlation
0.6

8. Find the expected return, variance and standard deviation of the

two-asset portfolio:
Asset
C
D

Return
9%
8.5%

Standard Deviation
15%
13%

Weight
50%
50%

Correlation
0.8

9. Find the expected return, variance and standard deviation of the

two-asset portfolio:
Asset
E
F

Return
12%
10%

Standard Deviation
19%
10%

Weight
30%
70%

Two-Asset Portfolios
10. Find the expected return (rf = 5 % and rM = 12%):
Stock
A
B

Beta
1.1
0.9

Correlation
0.4

C
D

1.4
1.2

11. Find the expected return (rf = 4.5% and rM = 11.5%):

Stock
A
B
C
D

Beta
0.95
1.01
1.29
1.19

12. If the expected return on a stock is 9.4% (assuming r f = 5.2%

and rM = 11.4%), what must be the beta?
13. If the expected return on a stock is 13.3% (assuming = 1.1
and rM = 12.5%), what must be the risk free rate?
14. If the expected return on a stock is 11.5% (assuming = 0.9
and rf = 5%), what must be the return on the market?

Solutions
Expected Rate of Return
1. Find the expected rate of return:
Probability
20%
30%
30%
20%

Return
-24%
0
5%
25%

E[r] .2(0.24) .3(0) .3(0.05) .2(0.25) 1.70%

2. Find the expected rate of return:

Probability
10%
20%
50%
20%

Return
-10%
-5%
15%
10%

E[r] .1(0.10) .2(0.05) .5(0.15) .2(0.10) 7.50%

3. Find the expected rate of return:

Probability
10%
30%
40%
20%

Return
-4%
0
15%
20%

E[r] .1(0.04) .3(0) .4(0.15) .2(0.20) 9.60%

Standard Deviation
4. Find the variance and standard deviation:
Probability
20%
30%
30%
20%

Return
-24%
0
5%
25%

r 1.70% (from problem 1)

2 .2(0.24 0.017)2 .3(0 0.017)2 .3(0.05 0.017)2 .2(0.25 0.017)2 0.0251

0.0251 0.1586
5. Find the variance and standard deviation:
Probability
10%
20%
50%
20%

Return
-10%
-5%
15%
10%

r 7.50% (from problem 2)

2 .1(0.1 0.075)2 .2(0.05 0.075)2 .5(0.15 0.075)2 .2(0.1 0.075)2 0.0110

0.0110 0.1049
6. Find the variance and standard deviation:
Probability
10%
30%
40%
20%

Return
-4%
0
15%
20%

r 9.60% (from problem 3)

2 .1(0.04 0.096)2 .3(0 0.096)2 .4(0.15 0.096)2 .2(0.20 0.096)2 0.0061

0.0061 0.0781
Two-Asset Portfolios
7. Find the expected return, variance and standard deviation of the
two-asset portfolio:
Asset
Return
Standard Deviation
Weight
Correlation
A
14%
20%
20%
0.6
B
12%
15%
80%
E[r] 0.2(0.14) 0.8(0.12) 12.40%

2 w A2 A2 wB2 B2 2w A wB A B A ,B
(0.2)2(0.2)2 (0.8)2(0.15)2 2(0.2)(0.8)(0.2)(0.15)(0.6) 0.0218

0.0218 0.1475
8. Find the expected return, variance and standard deviation of the
two-asset portfolio:
Asset

Return

Standard Deviation

Weight

Correlation

A
B

9.0%
8.5%

15%
13%

50%
50%

0.8

E[r] 0.5(0.90) 0.5(0.85) 8.75%

2 w A2 A2 wB2 B2 2wA wB A B A ,B
(0.5)2(0.15)2 (0.5)2(0.13)2 2(0.5)(0.5)(0.15)(0.13)(0.8) 0.0177

0.0177 0.1329
9. Find the expected return, variance and standard deviation of the
two-asset portfolio:
Asset
A
B

Return
12%
10%

Standard Deviation
19%
10%

Weight
30%
70%

E[r] 0.3(0.12) 0.7(0.1) 10.60%

2 w A2 A2 wB2 B2 2w A wB A B A ,B
(0.3)2(0.19)2 (0.7)2(0.1)2 2(0.3)(0.7)(0.19)(0.1)(0.4) 0.0113

0.0113 0.1065
Capital Asset Pricing Model (CAPM)
10. Find the expected return (rf = 5 % and rM = 12%):
Stock
A
B
C
D

Beta
1.1
0.9
1.4
1.2

E[rA ] rf rM rf 0.05 1.1 0.12 0.05 12.70%

E[rB ] rf rM rf 0.05 0.9 0.12 0.05 11.30%

E[rC ] rf rM rf 0.05 1.4 0.12 0.05 14.80%

E[rD ] rf rM rf 0.05 1.2 0.12 0.05 13.40%

11. Find the expected return (rf = 4.5% and rM = 11.5%):

Stock
A
B
C

Beta
0.95
1.01
1.29

Correlation
0.4

1.19

E[rA ] rf rM rf 0.045 0.95 0.115 0.045 11.15%

E[rB ] rf rM rf 0.045 1.01 0.115 0.045 11.57%

E[rC ] rf rM rf 0.045 1.29 0.115 0.045 13.53%

E[rD ] rf rM rf 0.045 1.19 0.115 0.045 12.83%

12. If the expected return on a stock is 9.4% (assuming r f = 5.2%

and rM = 11.2%), what must be the beta?
E[rA ] rf rM rf 0.094 0.052 0.112 0.052

0.094 0.052 0.112 0.052

0.094 0.052

0.112 0.052
0.70

13. If the expected return on a stock is 13.3% (assuming = 1.1

and rM = 12.5%), what must be the risk free rate?
E[rA ] rf rM rff 0.133 r 1.1 0.125 rf

0.133 rff 1.1 0.125 1.1 r

0.133 1.1 0.125 rff 1.1 r
0.133 1.1 0.125 0.1 rf
0.133 1.1 0.125

0.1
rf 4.50%

rf

14. If the expected return on a stock is 11.48% (assuming = 0.9

and rf = 5%), what must be the return on the market?

E[rA ] rf rM rf 0.1148 0.05 0.9 rM 0.05

0.1148 0.05 0.9 rM 0.05

0.1148 0.05
rM 0.05
0.9
0.1148 0.05
0.05 rM
0.9
rM 12.20%