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2. Compute the tangency and MVP portfolios. You may treat the average return on each stock as the expected return on that stock.
MVP Weights
ALL 5.27% Total of weights 100%
CAT 7.00% Variance 0
LMT 14.70% Std Dev 2.85%
DOW 10.87% Mean 8.83%
BUD 62.16% SR 2.28
3. Explain the following two puzzles briefly
a. BUD has the lowest average returns but highest positive portfolio weight in the MVP portfolio.
We suspect this is occurring for one of two reasons: First, the standard
deviation of BUD is the lowest of the group. This makes it an acceptable
security to introduce into a diversified portfolio. Second, judging by the
β of BUD compared to the others, you can see that BUD has the least
amount of correlation in terms of all of the other securities. This also
aids in its precedence when speaking of its weight in the MVP.
b. CAT has the highest excess return. Yet, its portfolio weight in the tangency portfolio is not the highest.
Although CAT does have the highest excess return, its level of risk is
also quite considerable. According to our data, CAD and LMT have the
highest risk of all the securities in our portfolio. The objective of the
tangency portfolio is to maximize return for a given risk level. CAT
does, in deed, give us a heavy return, but at the exposure to more risk
then would be safe to apply a heavy weight in our portfolio.
4. Re-compute the tangency and MVP portfolios by imposing a constraint that all the portfolio weights have to be positive.
*Note: re-computing the MVP would be redundant under these restraints due to the fact that the original MVP required no shorting.
a. Compare the standard deviation and Sharpe ratio of constrained and unconstrained portfolios?
The σ and sharp ratio are obviously more favorable without the
constraint set. Again, the objective of the tangency portfolio is to
maximize gain at a given risk. We are attempting to maximize this
return/risk ratio by maximizing our sharp ratio. Without the
constraints being placed, it gives the calculation free reign as to
whichever combination of weights it deems fit (while still being total
weight of 100%). In essence, the maximum return/risk ratio will be
given when there are no constraints embedded in the calculation.
5. Re-compute the tangency and MVP portfolios by recalculating the expected return on stocks (this problem assumes NO constraints)
a. Use the CAPM equation to calculate expected returns?
As you can see, there was no change in the weights from problem 2-5 in
terms of the MVP portfolio. This was due to the fact that even though
the E ( r ) figures were based upon a new model, the σ values were still
the same. Therefore, the minimum variance portfolio (which attempts
to minimize risk will gaining the most return) would maintain its
position. Aside that, we found it interesting that the securities that
problem 2 shows a short position, problem 5 has a significant long
position. Likewise, the only security that is short in the problem 5
tangency portfolio makes up a nearly 50% long position in problem 2!
6. Plot the efficiency frontier of only the 5 risky assets.
Please click here for efficient frontier data and chart (chart is near bottom of the screen).
Efficient frontier sheet
Please notice, original data is grouped (row 23-44) to reduce clutter on this page.
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Efficient frontier sheet
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Efficient frontier sheet
5.38 25.00%
5.14 24.00%
4.91 23.00%
4.68 22.00% Efficient Frontier
4.46 21.00% 25.00%
4.25 20.00% 24.00%
23.00%
4.05 19.00% 22.00%
15.00%
2.90 7.00% σ
2.96 6.00%
3.05 5.00%
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DATE ALL CAT LMT DOW BUD Market Rfree
AVG 1.42% 1.90% 1.44% 0.85% 0.36% 0.73% 0.19%
σ 4.96% 7.66% 6.07% 7.51% 3.50% 3.61% 0.12%
β 0.57 1.34 -0.19 1.08 0.22 1.00 0.00
E( r ) 17.09% 22.75% 17.25% 10.24% 4.33% 8.72% 2.33%
Check using slope 0.58 1.37 -0.19 1.10 0.22 1.00 0.00
SML Er=2.33+β(8.72-2.33)
0.06 Column C
0.06
0.05
0.05
0.04
MVP Weights 0.04
ALL 5.27% Total of weights 100% 0.03
0.03
CAT 7.00% Variance 0 0.02
0.02
LMT 14.70% Std Dev 2.85% 0.01
-0.25 0 0.25 0.5 0.75 1 1.25 1.5
DOW 10.87% Mean 8.83% β
BUD 62.16% SR 2.28
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