Portfolio Management & Security Analysis

QUESTION 1:

End of Period Returns

Probability

Return %

30

0.1

40

0.2

12

50

0.4

20

60

0.1

70

0.1

30

0.1

A. Calculate expected return?

E (R) = 0,1(3%) + 0,2(12%) + 0,4(20%) + 0,1(6%) + 0,1(7%) + 0,1(3%)

E (R) = 0,3 + 2,4 + 8 + 0,6 + 0,7 + 0,3
E (R) = 12.3%

B. Calculate the investment risk?

1.

Calculate end of period?

E (P) = 0,1(30) + 0,2(40) + 0,4(50) + 0,1(60) + 0,1(70) + 0,1(30)

E (P) = 3 + 8 + 20 + 6 + 7 + 3
E (P) = 47$

2. Calculate variance?
Var (P) = 0,1(30-47)2 + 0,2(40-47)2 + 0,4(50-47)2 + 0,1(60-47)2 + 0,1(70-47)2
+ 0,1(30 - 47)2
Var (P) = 28.9 + 9.8 + 3.6 + 16.9 + 52.9 + 28.9
Var (P) = 141$

C. Calculate the downside risk (standard deviation)?

Q2 (P) = Var ( P)
Q (P) = 141
Q (P) = 11.87$

D. What is covariance?

Covariance is a measure of the degree to which returns on two risky assets move in
tandem. A positive covariance means that asset returns move together. B negative
covariance means returns move inversely.
One method of calculating covariance is by looking at return surprises
(deviations from expected return) in each scenario.
Two methods are to multiply the correlation between the two variables by
the standard deviation of each variable.
If A and B have positive covariance, what does it mean?
A positive covariance means the variables are positively related to values indicate that
above average values of one. Variable are associated with above average values of the
other variable. Below average values are similarly associated.
If A and B have negative covariance, what does it mean?
A negative covariance means that there is an inverse relationship between one data
series and another of bonds or price of bonds.

E. How variance is related to covariance?

Variance and covariance are mathematical terms. Frequently used in statistics
and despite the similar sounding names. They actually have quite different meanings.
A covariance refers to the measure of how two random variables will change
together and is used to calculate the correlation between variables.
The variance refers to the spread of the data set. How far apart the numbers are
in relation to the mean for instance. Variance is particularly useful when
calculating the probability of future events or performance.
F. How covariance is related to correlation coefficient?

Correlation coefficient are between x & y. We just dont know to what degree.
How to get a better idea and how much of a correlation. Correlation coefficient is used
In order to attain this, the individual standard deviations must be calculated, and then
you divide the covariance. It is an expression that measures the proportion of the
variation in correlation that is explained by the variation in covariance

QUESTION 2:

Years

R(x) %

R(y) %

10

17

12

13

16

10

18

A. Calculate the covariance between security X and Y?

Calculate return of security (X)
E (Rx) =

(10 +12 +16 +18 )

4

= 14%
Calculate return of security (Y)
E (Ry) =

(17 + 13 +10 + 8 )
4

= 12%

B. calculate the covariance between security X and Y

CovXY =

[(1014)(1712)]+[(1214)(1312)]+[(1614)(1012)]+[(1814)(812)]
4

(202416)
4

42
4

= -10.5%
C. Calculate the correlation coefficient of X and Y?
Calculate standard deviation of X (Sx)

Qx=

[(1014)2+(1214)2+(1614) 2+(1814) 2]
4

Q2x =

(16+ 4+ 4+16)
4

Q2x = 10%
Qx = 10
Qx = 3.16%

Calculate standard deviation of X (Sy)

Qx=

[(1712) 2+(1312)2+(1012)2+(812)2]
4

Q2x =

(25+1+ 4+16)
4

Q2x = 11.5%
Qx = 11.5
Qx = 3.39%

Calculate the correlation coefficient of X and Y

RXY =

Cov ( X . Y )
Sx . Sy

RXY =

10.5
(3.16 x 3.39)

RXY = -0.98017