Assignment 1

1. Screening Stocks : Go to http://www.superstockscreener.com or any other screener and Select top 10 stocks
traded on NYSE with Min P/E=20 and Max P/E =50.

2. Go to finance.yahoo.com and look up the ticker symbols for the following companies: Citigroup, Alimentation
Couche Tard, Corus Entertainment, Kingsway Financial.

3. Supppose you buy a round lot of Horse Inc. stock on 55% margin when it is selling at $40 a share. The broker
charges a 10 percent annual interest rate and commissions are 4 percent of the total stock value on both the purchase
and the sale. If at year end you receive a $0.90 per share dividend and sell the stock for 35 5/8, what is your rate of
return on the investment?

4. Hedi Talbott has a margin account with a balance of $50,000. If initial margin requirements are 40 percent, and
Redcat Industries is currently selling at $50 per share.
a. How many shares of Redcat can Heidi buy?
b. If the maintenance margin is 25 percent, to what price can Redcat Industries fall before Heidi receives a margin
call?

5. End-of-month closing prices for 2 non-dividend-paying companies are presented below.

Month Security A Security B

1 67 6/8 52
2 70 2/8 56 5/8
3 69 3/8 54 2/8
4 68 4/8 55 4/8
5 66 2/8 56 7/8
6 65 57

Compute the risk-return for each stock using 68% interval.

6. Two securities, L and M, are perfectly negatively correlated. L's standard deviation is .6 and M's standard
deviation is .8. Find the portfolio of L and M that will result in the lowest possible risk level.

7.You have $10,000 invested, 30% of which is invested in Company X, which has an expected rate of return
of 15%, and 70% of which is invested in Company Y, with an expected return of 9%.
a. What is the dollar return to your portfolio?
b. What is the expected percentage rate of return?

8. Suppose that the standard deviation of returns from atypical share is about .40 (or 40 percent) a year. The
correlation between the returns of each pair of shares is about .3.
a. Calculate the variance and standard deviation of the returns on a portfolio that has equal investments in
two shares, three shares, and so on, up to 10 shares. Plot your results.
b. Use your estimates to draw a graph to show the relationship between the number of securities and risk.
How large is the underlying market risk that cannot be diversified away? Plot your results

1
9. Assume the following information
Stock E(r) Std Dev. Correlation Coefficients
1 .05 .20 1 with 2 = -.2
2 .10 .10 1 with 3 = .3
3 .20 .15 1 with 4 = .5
4 .15 .30 2 with 3 = .2
2 with 4 = -.5
3 with 4 = 0
A portfolio is formed as follows: Sell short $2,000 of security 1 and buy $3,000 of security 2, $2,000 of
security 3, and $3,000 of security 4. The cash provided by the owner of the portfolio is $2,000, and any
additional funds required to finance the portfolio are borrowed at a risk-free interest rate of 5%. There are no
restrictions on the use of short sale proceeds.

a. Construct the variance covariance matrix

b. Compute the portfolio weights for each component of the portfolio.
c. Compute the expected return of the portfolio.
d. Compute the standard deviation of the portfolio.

10. Suppose that the standard deviation of returns from atypical share is about .40 (or 40 percent) a year.
The correlation between the returns of each pair of shares is about .3.
a. Calculate the variance and standard deviation of the returns on a portfolio that has equal investments in
two shares, three shares, and so on, up to 10 shares. Plot your results.
b. Use your estimates to draw a graph to show the relationship between the number of securities and risk.
How large is the underlying market risk that cannot be diversified away? Plot your results.
c. Now repeat the problem, assuming that the correlation between each pair of stocks is zero. Plot your
results.

11. Here are returns and standard deviations for four investments.
Return Standard Deviation
Treasury bills 6% 0%
Stock P 10 14
Stock Q 14.5 28
Stock R 21 26
Calculate the standard deviations of the following portfolios :
a. 50 percent in Treasury bills, 50 percent in stock P.
b. 50 percent each in Q and R, assuming the shares have
• perfect positive correlation e•. -
• perfect negative correlation
• no correlation

12. For each of the following pairs of investments, state which would always be preferred by a rational
investor (assuming that these are the only investments available to the investor):
a. Portfolio A r = 18 percent σ = 20 percent
Portfolio B r = 14 percent σ = 20 percent
b. Portfolio C r = 15 percent σ = 18 percent
Portfolio D r = 13 percent σ = 8 percent
c. Portfolio E r = 14 percent σ = 16 percent
Portfolio F r = 14 percent σ = 10 percent

2
13. The Tuva Republic of the former USSR is an idyllic perfect market except that you are allowed to
invest in only one of the following cooperative funds - in addition to, of course, the Lenin Treasury bill,
which is issued by the Ministry of Finance, Moscow. The expected value and the standard deviation of
the cooperatives’ returns are given as follows:

Coop Funds A B C D E F
Std. Dev. 18 10 8 5 22 15
Exp. Return (%) 5 8 12 -2 17 15

a. Identify the set of efficient funds.

b. Which securities will everyone choose to invest in? Assume the Lenin T-bill is expected to yield 8%, and
you can buy or short sell it.
c. Compute the portfolio composition and its risk level that yield a 16% rate of return on average.

Presently, in the spirit of Glasnost, you find out from The Gorky Street Journal that, you can buy Lenin T-
bills at 10%.
d. How does this affect your answer to (c)?

14.You are planning to invest $200,000. You estimate the following probability distributions of returns for
Stock A and B:
Stock A Stock B

Probability Returns Probability Returns

.1 -10% .1 -30%
.2 5 .2 0
.4 15 .4 20
.2 25 .2 40
.1 40 .1 70
Corr (A,B) = -.5

a. What are the expected return and standard deviation for security A and security B?
b. What is the minimum variance portfolio?
c. Construct a table giving E (RP) and Standard deviation, and for portfolios with
W = 1.00, 0.75, 0.50, 0.25, 0.0 and the minimum risk portfolio.
d. Graph the feasible set of portfolios and identify the efficient section on the feasible set.
e. Suppose your risk return trade-off function or indifference curve is tangent to the efficient set at the point
where E(RP) = 18%.
i. Use this information plus the graph constructed in Part (d) to locate approximately your optimal
portfolio. Draw in a reasonable indifference curve.
ii) Compute the percentage and the dollar amount invested in each stock and determine the optimal
portfolio’s VAR(RP).
f. Now suppose a riskless asset with a return RF = 10% becomes available.
i) How would this change the investment opportunity set? Explain why the investment opportunity
set becomes linear.
ii) Given the indifference curve in Part (e), would you change your optimal portfolio? Explain