Tutorial 1 - Q&A

FINC712 Portfolio Management & Investment Analysis
Tutorial 1_Q&A
Question 1
On August 15, you purchased 100 shares of stock in Cara Cotton Company
at $65 a share and a year later you sold it for $61 a share. During the year
you received dividends of $3 a share. Calculate the HPR and HPY on your
investment in Cara Cotton.
Answer:
61 + 3 64
HPR = = =. 985
65 65
HPY = HPR - 1 =. 985 - 1 = - .015= -1.5%
Question 2
During the past 5 years you owned two stocks that had the following rates of
return:
Year Stock T Stock B

1 0.19 0.08
2 0.08 0.03
3 -0.12 -0.09
4 -0.03 0.02
5 0.15 0.04
a) Calculate the annual arithmetic mean rate of return for each stock.
Which stock is the most desirable by this measure?
b) Calculate the standard deviation of the annual rate of return for stock T.
Knowing that the standard deviation for stock B’s returns is equal to
0.06348, indicate which is the preferable stock by this measure.
c) Compute the coefficient of variation for each stock. According to this

measure of relative risk, which stock is preferable?
d) Compute the geometric mean rate of return for each stock. Discuss the
difference between the arithmetic and the geometric means for each
stock.
Tutorial 1_Q&A
Answers:
a)
n
HPYi
Arithmetic Mean ( AM)=∑
i=1 n
(. 19 )+(. 08)+(−. 12)+(−. 03 )+(.15 )
AMT =
5
.27
= =. 054
5
(.08 )+(. 03 )+(−.09 )+(. 02)+(. 04 )
AMB =
5
.08
= =. 016
5
Stock T is more desirable because the arithmetic mean annual rate of return is higher.
n
Standard Deviation ( σ )=
√ ∑ [ Ri −E( Ri ) ]2 /( n−1 )
i =1
b)
VarianceT =(.19−. 054 )2 +(. 08−.054 )2 +(−.12−.054 )2 +(−. 03−. 054 )2 +(. 15−.054 )2
¿ .01850+.00068+. 03028+. 00706+. 00922
¿ .06574
σ 2 =. 06574 /4=.01643
σ T =√ .01643=.1281
By this measure, B would be preferable as B stock bears lower risk ( σ B=0.06348)

Tutorial 1_Q&A
c)
Standard Deviation
Coefficient of Variation =
Expected Return
.1282
CVT = =2. 374
. 054
. 06348
CV B = =3 . 9675
. 016
By this measure, T would be preferable.
d) Geometric Mean (GM) = 1/n – 1
where  = Product of the HRs
GMT = [(1.19) (1.08) (.88) (.97) (1.15)]1/5 -1
= [1.26160] 1/5 –1 = 1.04757 –1 = .04757
GMB = [(1.08) (1.03) (.91) (1.02) (1.04)]1/5 -1
= [1.07383] 1/5 –1 = 1.01435 – 1 = .01435
If the returns were constant through time, the geometric mean would be the same as the
arithmetic mean. However, if the stock returns vary over time, the arithmetic mean will
always exceed the geometric mean. In this case, Stock T has more variability than Stock B.
The greater the variability of returns, the greater the difference between the arithmetic
and geometric mean returns.
Tutorial 1_Q&A
Question 3
You are considering acquiring shares of common stock in the Madison

Leather Corporation. Your rate of return expectations are as follows:
MADISON LEATHER CORP.

Possible rate of return Probability
-0.10 0.30
0.00 0.10
0.10 0.30
0.25 0.30
Calculate the expected return [E(Ri)] on your investment in Madison Leather

Corp.
Answer:
E(RMLC) = (.30) (-.10) + (.10) (0.00) + (.30) (.10) + (.30) (.25)
= (-.03) + .000 + .03 + .075 = .075
Question 4
During the past year, you had a portfolio that contained US government T-
bills (short-term government bonds), long-term government bonds and
common stocks. The rates of return on each of them were as follows:
US government T-bills 5.50%

US government long-term bonds 7.50%
US companies common stocks 11.60%
During the year, the consumer price index, which measures the general rise
in prices, went from 160 to 172. Calculate the rate of inflation during this
year. Calculate the real rates of return on each of the investment on your
portfolio based on the inflation rate.
Answers:
Tutorial 1_Q&A
CPI n+1 − CPIn

Rate of Inflation =
CPI n
where CPI = the Consumer Price Index
172-160 12
Rate of Inflation = = =. 075
160 160
HPR
Real Rate of Return = −1
1+rate of inflation
1 . 055
U. S . Government T-Bills = −1=. 9814−1=−. 0186
1 . 075
1. 075
U. S . Government LT bonds = −1=0
1. 075
1 .1160
U. S . Common Stocks = −1=1. 0381−1=.0381
1 .075

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FINC712 Portfolio Management & Investment Analysis

Year Stock T Stock B

c) Compute the coefficient of variation for each stock. According to this

By this measure, B would be preferable as B stock bears lower risk ( σ B=0.06348)

By this measure, T would be preferable.

d) Geometric Mean (GM) = 1/n – 1

where  = Product of the HRs

GMT = [(1.19) (1.08) (.88) (.97) (1.15)]1/5 -1

= [1.26160] 1/5 –1 = 1.04757 –1 = .04757

GMB = [(1.08) (1.03) (.91) (1.02) (1.04)]1/5 -1

= [1.07383] 1/5 –1 = 1.01435 – 1 = .01435

You are considering acquiring shares of common stock in the Madison

MADISON LEATHER CORP.

Calculate the expected return [E(Ri)] on your investment in Madison Leather

E(RMLC) = (.30) (-.10) + (.10) (0.00) + (.30) (.10) + (.30) (.25)

= (-.03) + .000 + .03 + .075 = .075

US government T-bills 5.50%

CPI n+1 − CPIn

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