Your investment advisor estimates that the expected return is 8.50% for the U.S.
ID: 2793302 • Letter: Y
Question
Your investment advisor estimates that the expected return is 8.50% for the U.S. stock market index and 6.90% (in dollar terms) for the Japanese stock market index for the year of 2018. On the other hand, the standard deviation of returns would be 12.6% for the U.S. market and 14.2% for Japanese market. In addition, the correlation coefficient between the two markets would be 0.38. After some thoughts, you decided to invest 30% of your investment fund in the Japanese market and the remaining 70% in the U.S. market.
a. Compute the expected return and the standard deviation risk of this international portfolio.
b. Compute the expected Sharpe ratio of this portfolio. The 1-year U.S. T-bill rate for 2018 is
1.80%.
Explanation / Answer
Expected return = 0.3*6.9% + 0.7*8.5% = 8.02%
standard deviation = SQRT(0.3*(6.9%-8.02%)2 + 0.7*(8.5%-8.02%)2 ) = 0.73%
Sharpe ratio = (Expected return - Risk free rate) / standard deviation
= (8.02% - 1.8%) / 0.73% = 8.52
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