UNIVERSIDAD DEL PACÍFICO

Foundations of Finance
Academic Term: 2020- I
Instructors: Luis Robles TAs: Nikoska Nicolas / Noelia Pérez
Alexei Álvarez Carlos Calderón / Juan Raunelli
Juan Manuel de los Ríos Jose Carlos Cortés / Pedro Blas
Fernando Bresciani Juan Huamani / Alonso Rojas
Jeferson Carbajal Eduardo Córdova / Gonzalo Vidalón
Carlos Arias Renzo Morales / Ariel Pajuelo

Question Bank – Topic 6 – Foundations of portfolio theory (Tutorial 9)

1. Which of the following statements is FALSE?

a) Idiosyncratic risk can be mitigated by naive portfolio diversification
b) Systematic risk is the specified risk related to each security
c) Total risk can be split into systematic risk and idiosyncratic risk
d) The risk of a portfolio is reduced when adding securities with negative correlation

2. Which of the following statements about correlation is least accurate?

a) Diversification reduces risk when correlation is less than +1
b) If the correlation coefficient is 0, a zero-variance portfolio can be constructed
c) The lower the correlation coefficient, the greater the potential benefits from diversification

3. Which of the following statements about risk-averse investors is most accurate? A risk-averse
investor:
a) Seeks out the investment with minimum risk, while return is not a major consideration.
b) Will take additional investment risk if sufficiently compensated for this risk
c) Avoids participating in global equity markets

4. Portfolios that plot inside the minimum-variance frontier represent

a) Efficient portfolios
b) Inefficient portfolios
c) Unattainable portfolios

5. In which of the following situations would you get the largest reduction in risk by spreading your
investment across two stocks?
a) The two shares are perfectly correlated
b) There is no correlation
c) There is modest negative correlation
d) There is perfect negative correlation

6. During the boom years 2003-2007, Ace mutual fund manager Diana Saurus produced the following
percentages rates of return. Rates of return on the market are given for comparison. Calculate the
average return and standard deviation of Ms. Sauro’s mutual fund. Did she do better or worse than
the market by these measures?

2003 2004 2005 2006 2007

Ms. Saurus +39.1 +11.0% +2.6% +18.0% +2.3%
 S&P 500 +31.6 +12.5% +6.4% +15.8% +5.6%
7. Pamela has decided to invest her savings in some securities. Pamela’s investment advisor told her
to buy stock from the technology sector:

Scenario Probability EA return Nintendo return iStore return

Recession 0.25 -40% 30% -35%
Neutral 0.40 15% 18% 10%
Growth 0.35 35% -28% 65%

a) Determine the expected return and risk for each stock.

b) Pamela and her husband decide to invest in only two stocks. They have $20,000 as
savings. One of their possible portfolios has the following wages: 70% (EA) and 30%
(iStore). Determine the risk and return for the portfolio and then compare them to the
individual stocks.
c) Given the next utility function, answer the following questions:

U =E ( r )−0.005 A σ 2

i. With the previous portfolio, what is the utility if A=100?

ii. With the previous portfolio, what is the utility if A=0?
iii. With the previous portfolio, what is the utility if A=-100?
iv. What does A state for?
v. If A=100, Will they choose the previous portfolio or one with E ( r )=10 % and
2
σ =20 %?

8. The following are the monthly rates of return for Coca Cola and for NVIDIA during a six-month
period:

Month Coca Cola NVIDIA

1 -0.04 0.07
2 0.06 -0.02
3 -0.07 -0.10
4 0.12 0.15
5 -0.02 -0.06
6 0.05 0.02

Determine:
a) Average monthly rate of return Ri for each stock
b) Standard deviation of returns for each stock
c) Covariance between the rates of return
d) The correlation coefficient between the rates of return
e) What level of correlation did you expect? How did your expectations compare with the
actual correlation? Would these two stocks offer a good chance for diversification? Why or
why not?
9. You are considering two assets with the following characteristics

E ( R1 ) =0.15 E ( σ 1 ) =0.10 w1 =0.5

E ( R2 ) =0.20 E ( σ 2 ) =0.20 w 2=0.5

Determine the mean and standard deviation of two portfolios if r 1 , 2=0.40 and -0.6, respectively.
Plot the two portfolios on a risk-return graph and briefly explain the results.

10. Consider two risky assets that have return variances of 0.0625 and 0.0324, respectively. Calculate
the variances and standard deviation of portfolio returns for an equal-weighted portfolio of the two
assets when their correlation of returns is 1, 0.5, 0 and -0.5.

11. Consider an Index that only have 2 stocks with the following information

E ( R1 ) =0.15 E ( σ 1 ) =3.8 w1=0.5

E ( R2 ) =0.11 E ( σ 2) =? w2=0.5

Determine the return of portfolio and standard deviation of each stock if the correlation between
them is 0 and the total risk of the portfolio is 5.2%.

12. A friend of yours needs your help for the estimation of some statistics for his portfolio. He gives you
the following information:

Year PVSA Bond return T-bond return

1 0.1 0.3
2 0.2 0.035
3 0.4 0.04
4 0.5 0.022
5 0.6 0.016
6 0.7 0.02

Determine the following

a) Average yearly rate of return and Standard deviation of returns for each bond.
b) Covariance between the rates of return

13. Consider the following information:

Expected Return Expected Risk Allocation

Coca Cola 0.00% 0.00% 15.00%
Tesla 1.70% 2.50% 45.00%
Amazon 1.90% 3.00% 25.00%
Netflix 3.30% 5.50% 10.00%
Graña y Montero 3.90% 7.20% 5.00%
 a) Calculate the portfolio return and volatility. Assume these securities are independent from
each other (covariance=0)
b) Assume there is a correlation of 80% between Graña y Montero and Amazon, and a
correlation of 40% between Tesla and Netflix. Calculate the portfolio return and volatility.

14. Consider the following information:

Security Expected Annual Return (%) Expected Standard Deviation

(%)
1 16 20
2 12 20

a) If the portfolio has an expected return of 15%, the proportion invested in Security 1 is:
a. 25%
b. 50%
c. 75%
b) If the correlation of returns between the two securities is -0.15, the expected standard deviation
of an equal-weighted portfolio is closest to:
a. 13.04%
b. 13.60%
c. 13.87%
c) If the two securities are uncorrelated, the expected standard deviation of an equal-weighted
portfolio is closest to:
a. 14.00%
b. 14.14%
c. 20.00%
d) As the number of assets in an equally-weighted portfolio increases, the contribution of each
individual asset’s variance to the volatility of the portfolio:
a. Increases
b. Decreases
c. Remains the same

15. Using the daily prices of the given Peruvian stocks, determine:
a) Variance and covariance matrix of returns
b) Correlation matrix of returns
c) Calculate the risk of a portfolio equally weighted between BAP, GRAM and CPAC.

16. Using the daily returns of the two portfolios, determine:

a) Average returns and standard deviations
b) If you decide to invest 50% in Choche Investments and the rest in PrimoDeChoche
Investments, calculate the expected return and standard deviation of the total portfolio.

17. The following are the annual returns of some assets, determine:
a) Average returns
b) Standard deviations
c) Compare the results between them and write some conclusions
18. Using the monthly prices of the given assets, determine:
a) Average returns and standard deviations
b) Variance and covariance matrix

19. You are considering in the portfolio composed of assets A, B and C

Assets

A B C

Market Capitalization 750 300 450

Average profitability 23.53 22.83 34.69

Standard deviation 1.6 0.76 1.11

Correlation matrix

A B C

A 1 -0.04 0.356

B -0.04 1 0.0025

C 0.356 0.0025 1

Using the information in the tables, determine

a) Weighting of each asset in the portfolio
b) The return of the portfolio
c) Portfolio risk measures

20. Suppose you have invested in only two stocks A and B. The returns from both depend on the next
three states of the economy that have the same.

State of the economy Stock A yield (%) Stock B yield (%)

Recession 6.3 -3.7

Normal 10.5 6.4

Boom 15.6 25.3

a) Calculate the expected return on each stock

b) Calculate the standard deviation of the returns for each stock
c) Calculate the covariance and correlation between the returns of the two stocks
21. Instrument F has an expected return of 12% and a standard deviation of 9% per year. Instrument G
has an expected return of 18% and a standard deviation of 25% per year.
a) What will be the expected return of a portfolio made up of 30% of instrument F and 70% of
G?
b) If the correlation between the returns to F and G is 0.2, what is the standard deviation of
the portfolio described in part a?
22. Consider the possible rates of return on stocks A and B over the following year:

State of the economy Probability of the state Performance of A if Performance of B if

occurring state occurs state occurs

Recession 0.2 7% -5%

Normal 0.5 7% 10%

Boom 0.3 7% 25%

a) Find the expected returns, variances, and standard deviations for stocks A and B.
b) Determine the covariance and correlation between the returns on Stock A and Stock B.
23. Suppose there are only two stocks in the world, A and B. The expected returns of those two stocks
are 10% and 20%, while the standard deviations of stocks are 5% and 15%, respectively. The
correlation between the returns of the two stocks is 0.
a) Calculate the expected return and the standard deviation of a portfolio that is made up of
30% of A and 70% of B.
b) Determine the expected return and the standard deviation of a portfolio that is made up of
90% of A and 10% of B

24. Maria is looking to obtain the Variance and Standard Deviation of AAPL and CMS and a portfolio of
50% each, but she doesn’t remember the formula she learned in class. Get the sd using a different
method and using the formula you learned in class, to show that both ways give the same result.
(hint: start by calculating the portfolio return for each day),

Stock Price Stock Price

Date
(AAPL) (CMS)
7/1/2018 46.223221 45.437225
8/1/2018 55.293457 46.283188
9/1/2018 55.026672 46.404709
10/1/2018 53.349594 46.897167
11/1/2018 43.530891 49.331047
12/1/2018 38.585068 47.36269
1/1/2019 40.713184 49.737976
2/1/2019 42.354534 52.283134
3/1/2019 46.663288 53.37878
4/1/2019 49.296772 53.388386
5/1/2019 43.007851 53.926598
 6/1/2019 48.808441 56.046986
7/1/2019 52.53714 56.347015
8/1/2019 51.47673 61.021626
9/1/2019 55.442406 62.302532
10/1/2019 61.579021 62.2733
11/1/2019 66.156113 60.080906
12/1/2019 72.9095 61.590279
1/1/2020 76.847343 67.147522
2/1/2020 67.871758 59.218407
3/1/2020 63.28677 57.929661
4/1/2020 73.119873 56.292839
5/1/2020 79.127747 57.762035
6/1/2020 91.035858 58.037716

25. Using the following data, calculate:

Expected
Weight Volatility
Return

Gold 20% 10% 39%

T-bonds 10% 5% 29%
Equities 40% 60% 30%
Crude 5% 30% 25%
Wheat 15% 25% 12%
EUR 10% 40% 7%

Correlation Matrix
Gold T-bonds Equities Crude Wheat EUR
Gold 1
T-bonds 0.5 1
Equities 0.5 0.5 1
Crude 0.5 0.5 0.5 1
Wheat 0.5 0.5 0.5 0.5 1
EUR 0.5 0.5 0.5 0.5 0.5 1

a. The expected return of the portfolio

b. Variance del Portafolio
c. Assuming a risk free of 10%, get the Sharpe Ratio

26. Calculate the optimum weights for the following portfolio assuming that we want to have a return of
15%. Use the Variance Covariance Matrix, Correlation Matrix, and the returns for each asset.
(Optional: calculate the efficient frontier for different values of target return [from 0% to 35%])

Variance Covariance Matrix (of asset returns)

1 2 3 4 5
1 2.2 0.9 -0.3 0.65 -0.42
2 0.9 1.5 -0.39 0.2 0.47
3 -0.3 -0.39 1.8 0.8 0.27
4 0.65 0.2 0.8 1.5 -0.5
5 -0.42 0.47 0.27 -0.5 1.7

Correlation matrix (of assets returns)

1 2 3 4 5
1 1 0.4954 -0.1508 0.3578 -0.2172
2 0.4954 1 -0.2373 0.1333 0.2943
3 -0.1508 -0.2373 1 0.4869 0.1543
4 0.3578 0.1333 0.4869 1 -0.3131
5 -0.2172 0.2943 0.1543 -0.3131 1

1 2 3 4 5
Returns 8.50% 18.30% 12.70% 10.80% 9.50%