CLO 1: Assess asset allocation decision and security selection strategies.
1. Use the questionnaire on page 719, to determine your risk tolerance. Use this information to help write a policy statement for you. (1 Mark)
2. Compare and contrast the investment objectives and constraints of a bank, an insurance company and defined benefit pension fund? (1 Mark)
3. Young people with little wealth should not invest money in risky assets such as the stock market because they can’t afford to lose what little money they have. Do you agree or disagree with this statement? Why? (1 Mark)
4. What is included in an investment policy statement and why is it important? (1 Mark)
Chapter 5: P.142-143 Do following problems:
11 a, b, c, d (0.5 mark each = 2 Marks)
12 a, b, c, d (0.5 mark each = 2 Marks)
13 a, b, c (0.5 mark each = 1.5 Marks)
14 a, b (0.5 mark each = 1 Mark)
P 144-145 Do following CFA problems:
2, 3, 4, 5, 6, 7, 8, 9, 11 (0.5 mark each = 4.5 Marks)
Part TWO Portfolio Theory
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 3%.
7. XY Z stock price and dividend history are as follows:
Year Beginning-of-Year Price Dividend Paid at Year-End
2010 $120 $2
201 1 $129 $2
2012 $115 $2
201 3 $1 20 $2
An investor buys six shares of XY Z at the beginning of 2010, buys another two shares at
the beginning of 2011, sells one share at the beginning of 2012, and sells all seven
remaining shares at the beginning of 2013. (Lo 5- 1)
a. What are the arithmetic and geometric average time-weighted rates of return for the
b. What is the dollar-weighted rate of return? (Hint: Carefully prepare a chart of cash
flows for the seven dates corresponding to the turns of the year for January 1, 2010, to
January 1, 2013. If your calculator cannot calculate internal rate of return, you will
have to use a spreadsheet or trial and error.)
8. a. Suppose you forecast that the standard deviation of the market return will be 20% in
the coming year. If the measure of risk aversion in Equation 5.13 is A = 4, what
would be a reasonable guess for the expected market risk premium?
[2. What value of A is consistent with a risk premium of 9%?
c. What will happen to the risk premium if investors become more risk tolerant?
9. Using the historical risk premiums as your guide, what is your estimate of the
expected annual HPR on the S&P 500 stock portfolio if the current risk-free interest
rate is 4%? (Lo 5-3)
10. What has been the historical average real rate of return on stocks, Treasury bonds, and
Treasury bills? (LO 5-2)
11. Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be
either $70,000 or $195,000, with equal probabilities of .5. The alternative riskless
investment in T-bills pays 4%. (Lo 5-3)
a. If you require a risk premium of 8%, how much will you be willing to pay for the
5 [2. Suppose the portfolio can be purchased for the amount you found in (a). What will
0 the expected rate of return on the portfolio be?
e c. Now suppose you require a risk premium of 11%. What is the price you will be willing
32 to pay now?
8 d. Comparing your answers to (a) and (c), what do you conclude about the relationship
Q between the required risk premium on a portfolio and the price at which the portfolio
4)? will sell?
g For Problems 12-16, assume that you manage a risky portfolio with an expected rate of
3 return of 12% and a standard deviation of 28%. The T-bill rate is 4%.
8 12. Your client chooses to invest 80% of a portfolio in your find and 20% in a T-bill money
market fund. (LO 5-3)
E a. What is the expected return and standard deviation of your client’s portfolio?
5. Suppose your risky portfolio includes the following investments in the given proportions:
0′) Stock A 20%
2 Stock B 30%
g Stock C 50%