978-0077861681 Chapter 9 Solution Manual Part 2

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LG2&5 9-27 Asset Allocation You have a portfolio with an asset allocation of 50 percent stocks,

40 percent long-term Treasury bonds, and 10 percent T-bills. Use these weights and the returns in

Table 9.2 to compute the return of the portfolio in the year 2000 and each year since. Then

compute the average annual return and standard deviation of the portfolio and compare them

with the risk and return profile of each individual asset class.

LG2&5 9-28 Asset Allocation You have a portfolio with an asset allocation of 35 percent stocks, 55

percent long-term Treasury bonds, and 10 percent T-bills. Use these weights and the returns in

Table 9.2 to compute the return of the portfolio in the year 2000 and each year since. Then

compute the average annual return and standard deviation of the portfolio and compare them

with the risk and return profile of each individual asset class.

2006 15.8% 1.85% 4.7% 7.02%

LG7 9-29 Portfolio Weights You have $15,000 to invest. You want to purchase shares of Alaska Air

at $42.88, Best Buy at $51.32, and Ford Motor at $8.51. How many shares of each company

should you purchase so that your portfolio consists of 30 percent Alaska Air, 40 percent Best

Buy, and 30 percent Ford Motor? Report only whole stock shares.

LG7 9-30 Portfolio Weights You have $20,000 to invest. You want to purchase shares of Xerox at

$17.34, Qwest at $8.15, and Liz Claiborne at $44.73. How many shares of each company should

you purchase so that your portfolio consists of 25 percent Xerox, 40 percent Qwest, and 35

percent Liz Claiborne? Report only whole stock shares.

LG7 9-31 Portfolio Return The following table shows your stock positions at the beginning of the

year, the dividends that each stock paid during the year, and the stock prices at the end of the

year. What is your portfolio dollar return and percentage return?

Company Shares

Beginning

of Year

Price

Dividen

d per

End of

Year

Price

US Bank 300 $43.50 $2.06 $43.43

PepsiCo 200 59.08 1.16 62.55

JDS Uniphase 500 18.88 16.66

Duke Energy 250 27.45 1.26 33.21

Solution by spreadsheet:

Company

Beginnin

g Value

Portfoli

Weight

Capital

Gain

Incom

e Total Return

Percentag

e Return

LG7 9-32 Portfolio Return The table below shows your stock positions at the beginning of

the year, the dividends that each stock paid during the year, and the stock prices at the end of the

year. What is your portfolio dollar return and percentage return?

Company Shares

Beginning

of Year

Price

Dividen

d per

End of

Year

Price

Johnson Controls 350 $72.91 $1.17 $85.92

Medtronic 200 57.57 0.41 53.51

Direct TV 500 24.94 24.39

Qualcomm 250 43.08 0.45 38.92

Solution by spreadsheet:

Portfoli

Capital

Incom

Company Beginnin

g Value

Total

Percen

Retur

LG3&4 9-33 Risk, Return, and Their Relationship Consider the following annual returns of Estee

Lauder and Lowe’s Companies:

Estee Lauder Lowe’s

Companies

Year 1 23.4% -6.0%

Year 2 -26.0 16.1

Year 3 17.6 4.2

Year 4 49.9 48.0

Year 5 -16.8 -19.0

Compute each stock’s average return, standard deviation, and coefficient of variation. Which

stock appears better? Why?

Solution by spreadsheet:

LG3&4 9-34 Risk, Return, and Their Relationship Consider the following annual returns of Molson

Coors and International Paper:

Molson

Coors

International

Paper

Year 1 16.3% 4.5%

Year 2 -9.7 -17.5

Year 3 36.5 -0.2

Year 4 -6.9 26.6

Year 5 16.2 -11.1

Compute each stock’s average return, standard deviation, and coefficient of variation. Which

stock appears better? Why?

Solution by spreadsheet:

Molson

Coors

International

Paper

9-35 Excel Problem Following are the monthly returns for October 2007 to March 2013 of three

international stock indices; All Ordinaries of Australia, Nikkei 225 of Japan, and FTSE 100 of

England.

All

Ordinari

NIKKEI

December-11 -1.76% 0.25% 1.22%

November-11 -4.03% -6.16%

–

0.70%

October-11 7.13% 3.31% 8.11%

September-11 -6.86% -2.85%

–

4.93%

7.23%

July-11 -3.42% 0.17%

–

2.19%

June-11 -2.70% 1.26%

–

0.74%

May-11 -2.25% -1.58%

–

1.32%

April-11 -0.60% 0.97% 2.73%

–

October-10 2.08% -1.78% 2.28%

September-10 4.46% 6.18% 6.19%

August-10 -1.52% -7.48%

–

0.62%

July-10 4.22% 1.65% 6.94%

June-10 -2.89% -3.95%

–

5.23%

–

December-09 3.55% 12.85% 4.28%

November-09 1.48% -6.87% 2.90%

October-09 -1.95% -0.97%

–

1.74%

September-09 5.69% -3.42% 4.58%

August-09 5.52% 1.31% 6.52%

February-09 -5.21% -5.32%

–

7.70%

January-09 -4.95% -9.77%

–

6.42%

December-08 -0.36% 4.08% 3.41%

November-08 -7.78% -0.75%

–

2.04%

October-08 -14.00% -23.83%

–

10.71

September-08 -11.20% -13.87%

–

13.02

August-08 3.22% -2.27% 4.15%

–

A. Compute and compare each indices’ monthly average return and standard deviation.

B. Compute the correlation between (i) All Ordinaries and Nikkei 225, (ii) All Ordinaries and

FTSE 100, and (iii) Nikkei 225 and FTSE 100, and compare them.

C. Form a portfolio consisting of one third of each of the indices and show the portfolio return

each year, and the portfolio’s return and standard deviation.

B. Correlations

Date

Portfo

lio

March-13 1.77%

July-12 0.47%

11 -0.10%

November–

11 -3.63%

January-11 -0.16%

December–

10 4.44%

November–

10 1.40%

August-09 4.45%

July-09 6.70%

June-09 1.43%

August-08 1.70%

July-08 -3.28%

March-08 -5.23%

February-08 -0.08%

–

research it!

Following a Portfolio

Following stocks in a portfolio is easier than ever. Many financial websites have the capability to

follow the stocks in your portfolio over time. Just enter your stocks, the number of shares, your

purchase price, and your commission cost and you can see how your portfolio is doing. These

portfolio managers will update your portfolio as stock prices change, minute to minute. Yahoo!

Finance has a portfolio management tool. Go to the site and start a portfolio to watch (which

requires free registration). Try entering symbols EBAY, T, LMT, DUK, and GSK. As a start,

The portfolio might look something like this:

integrated mini-case: Diversifying with Other Asset Classes

Many more types of investments are available besides stocks, bonds, and cash securities. Many

people invest in real estate and in precious metals, primarily gold. What are the risk and return

characteristics of these investments and do they provide diversification opportunities to the

typical stock investor?

You can invest in real estate in many ways. You can build properties, own rental units,

and trade raw land. These activities take enormous time and expertise. One of the easiest ways

to invest in real estate is through real estate investment trusts (REITs) that trade like stocks on

the stock exchanges. A REIT represents ownership in a portfolio consisting of a pool of real

estate assets. An index of all REITs is a good measure of the performance of the real estate

market. The following table shows the annual returns for the All REITs Index alongside the

returns of the S&P 500 Index.

S&P 500

Index

All REITs

Index

Gold

Price

1996 23.1% 35.8% -4.6%

1997 33.4% 18.9% -21.4%

1998 28.6% -18.8% -0.8%

1999 21.0% -6.5% 0.9%

2000 -9.1% 25.9% -5.4%

2001 -11.9% 15.5% 0.7%

2002 -22.1% 5.2% 25.6%

Gold has been a highly sought-after asset all over the world, and has retained at least

some economic value over thousands of years. The United States has had a very chaotic history

with gold. Americans have sought to “strike it rich” through gold rushes in North Carolina (early

1800s), California and Nevada (mid-1800s), and Alaska (late 1800s). Struggling in the Great

Depression, President Franklin D. Roosevelt ordered U.S. citizens to hand in all the gold they

possessed. The ban on U.S. citizens owning gold was not lifted until the end of 1974. The table

also shows the return from gold prices.

The returns for stocks, real estate, and gold are all volatile. However, during many years,

the return of one asset is up while the others are down. This looks promising for diversification

opportunities.

a. Using a spreadsheet, compute the average return and standard deviation of each of the

three asset classes.

b. Compute the annual returns of a portfolio consisting of 50 percent stocks / 40 percent real

estate / 10 percent gold. What is the average return and standard deviation of this portfolio?

Also compute the average return and standard deviation of the following portfolios: 75

percent/20 percent/5 percent and 80 percent/5 percent/15 percent. How do these portfolios

perform compared to owning just stocks?

c. Plot the average return and standard deviation of the three assets and the three portfolios

on a risk-return graph like Figure 9.3.

SOLUTION:

S&P 500

All REITs

Gold

8.4%

13.9%

13.0%

12.3%

12.9%

50/40/10

75/20/5

80/5/15

S&P 500 Index

All REITs

Index

Gold Price

Standard Deviation of Annual Returns

Average Return