An investor is evaluating the possibility of buying shares in two companies. Com
ID: 2786156 • Letter: A
Question
An investor is evaluating the possibility of buying shares in two companies. Company c and company d. the following probability distribution of returns covering different economic conditions is provided
excellent (probability) 0.2 Coy c returns 10% Coy D returns 19%
normal (probability) 0.5 13% 18
poor (probability) 0.3 14% 14
cal : weighted average for both 70% in company C and 30% invested in company D
:weighted risk both 70% in company C and 30% invested in company D
:the portfolio return both 70% in company C and 30% invested in company D
:the portfolio risk both 70% in company C and 30% invested in company D
bsequent value of $2.30 per share. Question 6 (20 Marks) An investor is evaluating the possibility of buying shares in two companies, Company C and Company D. The following probability distribution of returns covering diféerent economic conditions is provided $12.000 Probability 02 0.5 0.3 Coy C returns % 10 13 14 Coy D returns 96 19 18 14 Conditions Excellent Normal Poor verhaul Required: Calculate (a) The expected returns for cach company (b) The standard deviation (risk) of the expected returns for each company. (c) The weighted return for a portfolio where 70% is invested in Company C and 30% is invested in Company D. The weighted risk for a portfolio where 70% is invested in Company C and 30% (d) is invested in Company D. Theportfolio return where70% is invested in Company Cand 30% inCompany D. Theportfolio risk where 70% is invested in Company Cand 30% in Company D. (e) (9) Using (some of) your answers to the above, show how diversification har reduced risk.Explanation / Answer
A
Economic conditions
probability
return
probability*return
Economic conditions
probability
return
probability*return
Excellent
0.2
10
2
Excellent
0.2
19
3.8
normal
0.5
13
6.5
normal
0.5
18
9
Poor
0.3
14
4.2
Poor
0.3
14
4.2
average return of company C
12.7
average return of company D
17
B
Economic conditions
probability
return
return-average return
square of (return-average return)
Probability*square of (return-average return)
Economic conditions
probability
return
return-average return
square of (return-average return)
Probability*square of (return-average return)
Excellent
0.2
10
-2.7
7.29
1.458
Excellent
0.2
19
2
4
0.8
normal
0.5
13
13
169
84.5
normal
0.5
18
18
324
162
Poor
0.3
14
1.3
1.69
0.507
Poor
0.3
14
-3
9
2.7
average return of company C
12.7
average return of company D
17
Variance = sum of (probability*(square of return-average return))
86.465
Variance = sum of (probability*(square of return-average return))
165.5
standard deviation = square root of variance
9.298656
standard deviation = square root of variance
12.86468
C-
D-
Security
Weight
Average return
weight*average return
Security
Weight
Average return
weight*average return
C
0.7
12.7
8.89
C
0.7
9.298656
6.509059
D
0.3
17
5.1
D
0.3
12.86468
3.859404
Weighted average return on portfolio
sum of weight*average return
13.99
Weighted average risk on portfolio
sum of weight*standard deviation
10.36846
E-
F-
Security
Weight
Average return
weight*average return
Security
Weight
Average return
weight*average return
C
0.3
12.7
3.81
C
0.3
9.298656
2.789597
D
0.7
17
11.9
D
0.7
12.86468
9.005276
Weighted average return on portfolio
sum of weight*average return
15.71
Weighted average risk on portfolio
sum of weight*standard deviation
11.79487
H-
As it is depicted from the fact that risk on Security C and D is 9.29% and 12.86% but when portfolio is created it has reduced to 10.36% and 11.79% due to diversification
A
Economic conditions
probability
return
probability*return
Economic conditions
probability
return
probability*return
Excellent
0.2
10
2
Excellent
0.2
19
3.8
normal
0.5
13
6.5
normal
0.5
18
9
Poor
0.3
14
4.2
Poor
0.3
14
4.2
average return of company C
12.7
average return of company D
17
B
Economic conditions
probability
return
return-average return
square of (return-average return)
Probability*square of (return-average return)
Economic conditions
probability
return
return-average return
square of (return-average return)
Probability*square of (return-average return)
Excellent
0.2
10
-2.7
7.29
1.458
Excellent
0.2
19
2
4
0.8
normal
0.5
13
13
169
84.5
normal
0.5
18
18
324
162
Poor
0.3
14
1.3
1.69
0.507
Poor
0.3
14
-3
9
2.7
average return of company C
12.7
average return of company D
17
Variance = sum of (probability*(square of return-average return))
86.465
Variance = sum of (probability*(square of return-average return))
165.5
standard deviation = square root of variance
9.298656
standard deviation = square root of variance
12.86468
C-
D-
Security
Weight
Average return
weight*average return
Security
Weight
Average return
weight*average return
C
0.7
12.7
8.89
C
0.7
9.298656
6.509059
D
0.3
17
5.1
D
0.3
12.86468
3.859404
Weighted average return on portfolio
sum of weight*average return
13.99
Weighted average risk on portfolio
sum of weight*standard deviation
10.36846
E-
F-
Security
Weight
Average return
weight*average return
Security
Weight
Average return
weight*average return
C
0.3
12.7
3.81
C
0.3
9.298656
2.789597
D
0.7
17
11.9
D
0.7
12.86468
9.005276
Weighted average return on portfolio
sum of weight*average return
15.71
Weighted average risk on portfolio
sum of weight*standard deviation
11.79487
H-
As it is depicted from the fact that risk on Security C and D is 9.29% and 12.86% but when portfolio is created it has reduced to 10.36% and 11.79% due to diversification
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