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Bodie-Kane-Marcus: Essentials of Investments, Fifth Edition
II. Portfolio Theory
5. Risk and Return: Past and Prologue
© The McGraw-H Companies, 2003
Part TWO Portfolio Theory
Use Equations 5.3-5.5 to compute the mean and standard deviation of the HPR on stocks. Compare your revised parameters with the ones in the text.
5. The stock of Business Adventures sells for $40 a share. Its likely dividend payout and end-of-year price depend on the state of the economy by the end of the year as follows:
Dividend Stock Price
Normal economy 1.00 43
Recession .50 34
a. Calculate the expected holding-period return and standard deviation of the holding-period return. All three scenarios are equally likely.
b. Calculate the expected return and standard deviation of a portfolio invested half in Business Adventures and half in Treasury bills. The return on bills is 4%.
Use the following data in answering questions 6, 7, and 8.
Utility Formula Data
Expected Standard
Investment Return E(r) Deviation a
6. Based on the utility formula above, which investment would you select if you were risk averse with A = 4?
7. Based on the utility formula above, which investment would you select if you were risk neutral?
8. The variable (A) in the utility formula represents the:
a. investor's return requirement.
b. investor's aversion to risk.
c. certainty equivalent rate of the portfolio.
d. preference for one unit of return per four units of risk.
Use the following expectations on Stocks X and Y to answer questions 9 through 12 (round to the nearest percent).
Bodie-Kane-Marcus: Essentials of Investments, Fifth Edition
II. Portfolio Theory
5. Risk and Return: Past and Prologue
© The McGraw-H Companies, 2003
5 Risk and Return: Past and Prologue
Bear Market Normal Market Bull Market
Probability 0.2 0.5 0.3
9. What are the expected returns for Stocks X and Y?
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