Your portfolio consists of Microsoft and Google. On September 15, you fully inve

Question

Your portfolio consists of Microsoft and Google. On September 15, you fully invested you $1,000 on these two stocks with 50% of your money going into Microsoft (purchase price=$25 per share) and Google was purchased at $500 per share. On November 8, you sold your Microsoft at $29 a share and Google at $485 a share. Assume there is no cost to buy stocks but there is a $20 total commission charge to sell a stock up to 2500 shares. Compute this portfolio's rate of return for the period and annualize the return. Why is it necessary to compare yout portfolio's performance against a certain index?

Explanation / Answer

Stocks of microsoft purchased=500/25=20

Return on Microsoft=(20*Selling Price - 20*purchase price- commission )/(20*purchase price)

Return on Microsoft=(20*29- 20*25- 20)/(20*25)

Return on Microsoft=(580- 500- 20)/(500)

Return on Microsoft=(60)/(500)=12%

Stocks of Google purchased=500/500=1

Return on Google =(1*Selling Price -1*purchase price- commission )/(1*purchase price)

Return on Google =(1*485- 1*500- 20)/(1*500)

Return on Google =(485- 500- 20)/(500)

Return on Google =(-35)/(500)=-7%

portfolio's rate of return for the period =0.50*12% + 0.50 * (-7%)

portfolio's rate of return for the period =6% - 3.5%

portfolio's rate of return for the period =2.5%

annualized return=(1.025)^(365/54) - 1 = 0.1816= 18.16% (54 days between September 15 and November 8)

it is necessary to compare your portfolio's performance against a certain index to measure the portfolio performance relative to a benchmark.If the portfolio replicates a index for e.g. a portfolio of value securities replicates a value index then its necessary to find if the portfolio performs well or poorly against the benchmark/index.The index provides a suitable benchmark against which to appraise the performance of the portfolio.

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