Spreadsheet 6.

1
Capital market expectations for stock and bond funds
Stock Fund
Scenario Probability Rate of Return Col B x Col C
Severe recession 0.05 -37 -1.9
Mild recession 0.25 -11 -2.8
Normal growth 0.40 14 5.6
Boom 0.30 30 9.0
Expected or Mean Return: SUM: 10.0
 Bond Fund
Rate of Return Col B x Col E
-9 -0.5
15 3.8
8 3.2
-5 -1.5 0 0 0
SUM: 5.0 0 0 #VALUE!
0.0 0 0 0
0.0 0 0 0
3.5 #VALUE!
1.87082869338697 #VALUE!
Spreadsheet 6.2
Variance of returns
Stock Fund Bond Fund
Deviation Deviation
Rate from Column B Rate from
of Expected Squared x of Expected
Scenario Prob. Return Return Deviation Column E Return Return
Severe recession 0.05 -37 -47 2209 110.45 -9 -14
Mild recession 0.25 -11 -21 441 110.25 15 10
Normal growth 0.40 14 4 16 6.40 8 3
Boom 0.30 30 20 400 120.00 -5 -10
Variance = SUM 347.10
Standard deviation = SQRT(Variance) 18.63

Mean (Stock Fund) 10

Mean (Bond Fund) 5
Bond Fund

Column B
Squared x
Deviation Column I
196 9.80
100 25.00
9 3.60
100 30.00
Variance: 68.40
Std. Dev.: 8.27
Spreadsheet 6.3
Performance of a portfolio invested in the stock and bond funds
Portfolio invested 40% in stock fund and 60% in bond fund
Rate Column B Deviation from Column B
of x Expected Squared x
Scenario Probability Return Column C Return Deviation Column F
Severe recession 0.05 -20.20 -1.01 -27.2 739.84 36.99
Mild recession 0.25 4.60 1.15 -2.4 5.76 1.44
Normal growth 0.40 10.40 4.16 3.4 11.56 4.62
Boom 0.30 9.00 2.7 2.0 4.00 1.20
Expected return: 7.00 Variance: 44.26
Standard deviation: 6.65

0.4 Weight in Stocks a 0.6 Weight in Bonds

Spreadsheet 6.4
Covariance between the returns of the stock and bond funds
Return Deviation from Mean
Scenario Probability Stock Fund ReturnBond Fund Return Stock Fund
Severe recession 0.05 -37 -9 -47.00
Mild recession 0.25 -11 15 -21.00
Normal growth 0.40 14 8 4.00
Boom 0.30 30 -5 20.00

Mean(Stock Fund) 10.00

Mean(Bond Fund) 5.00
Standard Deviation(Stock Fund) 18.63
Standard Deviation(Bond Fund) 8.27
n from Mean
Bond Fund P*Deviation Stock*Deviation Bond
-14.00 32.9
10.00 -52.5
3.00 4.8
-10.00 -60
Covariance -74.8
Correlation Coefficient -0.485
Spreadsheet 6.5
The investment opportunity set with the stock and bond funds

E(rS)
10
Portfolio Weights
wS = 1–wB
-0.2
-0.1
0.0
0.0932
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
1.1
1.2
Notes:
1. Negative weights indicate short positions
2. The weights of the minimum-variance portfolio are
computed using the formula in footnote 1.
 Input Data
E(rB) sS sB rBS
5 19 8 0.2
C
Expected Return, E(rP) Std Dev
12.0
wB Mean Std Dev
1.2 4.0 9.59 10.0
1.1 4.5 8.62
8.0
1.0 5.0 8.00

Axis Title
0.9068 5.5 7.80 6.0
0.9 5.5 7.81
4.0
0.8 6.0 8.07
0.7 6.5 8.75 2.0
0.6 7.0 9.77
0.5 7.5 11.02 0.0
6.00 8.00 10.00 12.00
0.4 8.0 12.44
0.3 8.5 13.98
0.2 9.0 15.60
0.1 9.5 17.28
0.0 10.0 19.00
-0.1 10.5 20.75
-0.2 11.0 22.53
 Chart Title
0

0
6.00 8.00 10.00 12.00 14.00 16.00 18.00 20.00 22.00 24.00
Axis Title
Spreadsheet 6.6
Investment opportunity set for stocks and bonds with various correlation coefficients
Input Data
E(rS) E(rB) sS
10 5 19

Weight in stocks Portfolio expected return Portfolio Standard Deviation1 for Given
wS E(rP) = Col A*A3 + (1 - Col A)*B3 -1
-0.1
0.0
0.1
0.2
0.3
0.4
0.6
0.8
1.0
1.1

wS(min) = (sB^2 - sBsSr) / (sS^2 + sB^2 - 2*sBsSr) =

E(rP) = wS(min)*A3+(1-wS(min))*B3 =
sP =
Notes:
1. sP = SQRT[ (Col A*C3)^2 + ((1 - Col A)*D3)^2 + 2*Col A*C3*(1 - Col A)*D3* r ]
2. The standard deviation is calculated from equation 6.6 using the weights of the miniumum-variance portfolio
3. As the correlation coefficient grows, the minimum variance portfolio requires a smaller position in stocks (eve
negative position for higher correlations), and its performance becomes less attractive.
4. Notice that with correlation of .5 or higher, minimum variance is achieved with a short position in stocks.
The standard deviation is lower than that of bonds, but the mean is lower as well.
5. With perfect positive correlation (column G), you can drive the standard deviation to zero by taking a large,
short position in stocks. The mean return is then as low as 1.36%.
elation coefficients

sB
8

lio Standard Deviation1 for Given Correlation, r

0 0.2 0.5 1

Minimum Variance Portfolio2,3,4,5

s of the miniumum-variance portfolio:

uires a smaller position in stocks (even a
ess attractive.
ed with a short position in stocks.

deviation to zero by taking a large,

 Expected Return Standard Deviation
Stock Fund(S) 15% 32%
Bond Fund(B) 9% 23%
Treasury Bill 5.50%
Correlation Coefficient be 0.15

Draw the opportunity set of stock and bond funds.

Find the optimal risky portfolio (O), its expected return, standard deviation, Sharpe ratio. Compare the
Find the slope of the CAL generated by T-bills and risky portfolio (O).

Suppose an investor places 2/9(22.22%) of the complete portfolio in the risky portfolio O and the remainder
complete portfolio, its expected return and SD and Sharpe ratio.

Weight of Stock Fund Weight of Bond Fund Expected Return

-100% 200% 3.00%
-90% 190% 3.60%
-80% 180% 4.20%
-70% 170% 4.80%
-60% 160% 5.40%
-50% 150% 6.00%
-40% 140% 6.60%
-30% 130% 7.20%
-20% 120% 7.80%
-10% 110% 8.40%
0% 100% 9.00%
10% 90% 9.60%
20% 80% 10.20%
30% 70% 10.80%
40% 60% 11.40%
50% 50% 12.00%
60% 40% 12.60%
70% 30% 13.20%
80% 20% 13.80%
90% 10% 14.40%
100% 0% 15.00%
110% -10% 15.60%
120% -20% 16.20%
130% -30% 16.80%
140% -40% 17.40%
150% -50% 18.00%
160% -60% 18.60%
170% -70% 19.20%
180% -80% 19.80%
190% -90% 20.40%
200% -100% 21.00%
 Weight of Stock
wS(min) = (sB^2 - sBsSr) / (sS^2 + sB^2 - 2*sBsSr) =
E(rP) = wS(min)*A3+(1-wS(min))*B3 =
sP =
Tangency Portfolio Weight 0.6466

Tangency Portfolio Expected Return

Tangency Portfolio Standard Deviation

Slope/Sharpe Ratio of Minimum Variance Portfolio

Slope/Sharpe Ratio of Tangency Portfolio

Standard Deviation Expected Return of CAL

Risky Portfolio(22.22%)
Weights
Mean of the Complete Portfolio
Standard Deviation of the Complete Portfolio

Weights of Stocks in the Complete Portfolio

Weights of Bonds in the Complete Portfolio
Weights of Treasury Bills in the Complete Portfolio
Total
n, Sharpe ratio. Compare the

he risky portfolio O and the remainder in T-bills. Calculate the composition of the
ected return and SD and Sharpe ratio.

Standard Deviation
51.9%
48.6%
45.3%
42.0%
38.9%
35.8%
32.8%
30.0%
27.4%
25.0%
23.0%
21.4%
20.4%
19.9%
20.2% Chart Title
21.1% 25.00%
22.5%
24.4% 20.00%
26.7%
29.2%
15.00%
32.0%
34.9%
38.0% 10.00%
41.1%
44.4% 5.00%
47.7%
51.0%
0.00%
54.4% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0%
57.8%
61.2%
64.7%
Weight of Bond

0.3534 (given)

Risk Free Bills

.0% 70.0%
 Expected Return
Stock Fund(S) 15%
Bond Fund(B) 10%
Treasury Bill 5.00%
Correlation Coefficient -0.2

Draw the opportunity set of stock and bond funds.

Find the optimal risky portfolio (O), its expected return, standard deviation, Sharpe ratio. Compare the
Find the slope of the CAL generated by T-bills and risky portfolio (O).

Suppose an investor places 2/9(22.22%) of the complete portfolio in the risky portfolio O and the remainder
expected return and SD and Sharpe ratio.

Weight of Stock Fund Weight of Bond Fund

-100% 200%
-90% 190%
-80% 180%
-70% 170%
-60% 160%
-50% 150%
-40% 140%
-30% 130%
-20% 120%
-10% 110%
0% 100%
10% 90%
20% 80%
30% 70%
40% 60%
50% 50%
60% 40%
70% 30%
80% 20%
90% 10%
100% 0%
110% -10%
120% -20%
130% -30%
140% -40%
150% -50%
160% -60%
170% -70%
180% -80%
190% -90%
200% -100%
 wS(min) = (sB^2 - sBsSr) / (sS^2 + sB^2 - 2*sBsSr) =
E(rP) = wS(min)*A3+(1-wS(min))*B3 =
sP =
Tangency Portfolio Weight

Tangency Portfolio Expected Return

Tangency Portfolio Standard Deviation

Slope/Sharpe Ratio of Minimum Variance Portfolio

Slope/Sharpe Ratio of Tangency Portfolio

Standard Deviation Expected Return of CAL

Weights
Mean of the Complete Portfolio
Standard Deviation of the Complete Portfolio

Weights of Stocks in the Complete Portfolio

Weights of Bonds in the Complete Portfolio
Weights of Treasury Bills in the Complete Portfolio
Total
 Standard Deviation
50%
20%
0

arpe ratio. Compare the

ky portfolio O and the remainder in T-bills. Calculate the composition of the complete portfolio, its
return and SD and Sharpe ratio.

Expected Return Standard Deviation

Weight of Stock Weight of Bond

0.2564 0.7436 given

Risky Portfolio(22.22%) Risk Free Bills

A project has a 0.7 chance of doubling your investment in a year and a 0.3 chance of halving your investment in a year. What
the rate of return on this investment?
vestment in a year. What is the standard deviation of
Investors expect the market rate of return this year to be 10%. The expected rate of return on a stock with a beta of 1.2 is cu
the market return this year turns out to be 8%, how would you revise your expectation of the rate of return on the st
stock with a beta of 1.2 is currently 12%. If
of the rate of return on the stock?
 Excess Excess
T-bill Return of Return of
Month S&P 500 AAPL (monthly) S&P 500 AAPL
201301 0.05236 -0.14409 0.00006
201302 0.01301 -0.02512 0.00008
201303 0.03758 0.00286 0.00008
201304 0.01962 0.00027 0.00005
201305 0.02312 0.02260 0.00003
201306 -0.01360 -0.11830 0.00004
201307 0.05067 0.14123 0.00003
201308 -0.02921 0.08339 0.00003
201309 0.03166 -0.02148 0.00002
201310 0.04627 0.09639 0.00004
201311 0.03082 0.06967 0.00006
201312 0.02595 0.00890 0.00006
201401 -0.03467 -0.10770 0.00003
201402 0.04576 0.05731 0.00004
201403 0.00806 0.01995 0.00004
201404 0.00656 0.09940 0.00002
201405 0.02331 0.07829 0.00002
201406 0.02064 0.02766 0.00003
201407 -0.01397 0.02873 0.00002
201408 0.03978 0.07709 0.00002
201409 -0.01393 -0.01707 0.00002
201410 0.02397 0.07196 0.00002
201411 0.02763 0.10556 0.00002
201412 -0.00247 -0.07189 0.00002
201501 -0.02943 0.06142 0.00002
201502 0.05701 0.10046 0.00002
201503 -0.01499 -0.03137 0.00002
201504 0.00910 0.00579 0.00002
201505 0.01252 0.04515 0.00002
201506 -0.01934 -0.03727 0.00002
201507 0.02130 -0.03289 0.00002
201508 -0.06009 -0.06612 0.00006
201509 -0.02455 -0.02182 0.00002
201510 0.08345 0.08341 0.00002
201511 0.00337 -0.00569 0.00010
201512 -0.01525 -0.11023 0.00019
201601 -0.04910 -0.07524 0.00022
201602 -0.00174 -0.00134 0.00026
201603 0.06734 0.12721 0.00024
201604 0.00375 -0.13992 0.00019
201605 0.01849 0.07137 0.00023
201606 0.00268 -0.04266 0.00023
201607 0.03657 0.09006 0.00025
201608 0.00125 0.02361 0.00025
201609 0.00045 0.06550 0.00024
201610 -0.01796 0.00433 0.00028
201611 0.03579 -0.02158 0.00038
201612 0.01920 0.04796 0.00043
201701 0.01910 0.04775 0.00043
201702 0.03970 0.13358 0.00043
201703 0.00120 0.04869 0.00062
201704 0.01030 -0.00007 0.00067
201705 0.01410 0.06780 0.00074
201706 0.00620 -0.05721 0.00082
201707 0.02060 0.03270 0.00089
201708 0.00310 0.10691 0.00084
201709 0.02060 -0.06024 0.00086
201710 0.02330 0.09681 0.00089
201711 0.03070 0.02035 0.00103
201712 0.01110 -0.01525 0.00110
Date P&G Price S&P 500 Index Risk Free Rate
January-17 2,278.87 2,275.12 0.5
February-17 2,363.64 2,329.91 0.523
March-17 2,362.72 2,366.82 0.738
April-17 2,384.20 2,359.31 0.78
May-17 2,411.80 2,395.35 0.95
June-17 2,423.41 2,433.99 0.993
July-17 2,470.30 2,454.10 1.053
August-17 2,471.65 2,456.22 0.978
September-17 2,519.36 2,492.84 1.028
October-17 2,575.26 2,557.00 1.123
November-17 2,647.58 2,593.61 1.238
December-17 2,673.61 2,664.34 1.355
January-18 2,823.81 2,789.80 1.43
February-18 2,713.83 2,705.16 1.618
March-18 2,640.87 2,702.77 1.67
April-18 2,648.05 2,653.63 1.763
May-18 2,705.27 2,701.49 1.87
June-18 2,718.37 2,754.35 1.88
July-18 2,816.29 2,793.64 1.985
August-18 2,901.52 2,857.82 2.055
September-18 2,913.98 2,901.50 2.15
October-18 2,711.74 2,785.46 2.278
November-18 2,760.17 2,723.23 2.308
December-18 2,506.85 2,567.31 2.3
January-19 2,704.10 2,607.39 2.34
February-19 2,784.49 2,754.86 2.383
March-19 2,834.40 2,803.98 2.328
April-19 2,945.83 2,903.80 2.368
May-19 2,752.06 2,854.71 2.293
June-19 2,941.76 2,890.17 2.035
July-19 2,980.38 2,996.11 2.03
August-19 2,926.46 2,897.50 1.933
September-19 2,976.74 2,982.16 1.77
October-19 3,037.56 2,977.68 1.498
November-19 3,140.98 3,104.90 1.54
December-19 3,230.78 3,176.75 1.505
January-20 3,225.52 3,278.20 1.51
February-20 2,954.22 3,277.31 1.23
March-20 2,584.59 2,652.39 0.03
April-20 2,912.43 2,761.98 0.09
May-20 3,044.31 2,919.61 0.128
June-20 3,100.29 3,104.66 0.135
July-20 3,271.12 3,207.62 0.083
August-20 3,500.31 3,391.71 0.095
September-20 3,363.00 3,365.52 0.085
October-20 3,269.96 3,418.70 0.083
November-20 3,621.63 3,548.99 0.075
 December-20 3,756.07 3,695.31 0.065
January-21 3,714.24 3,793.75 0.048
February-21 3,811.15 3,883.43 0.035
March-21 3,972.89 3,910.51 0.013
April-21 4,181.17 4,141.18 0.003
May-21 4,204.11 4,167.85 0.008
June-21 4,297.50 4,238.49 0.04
July-21 4,395.26 4,363.71 0.04
August-21 4,522.68 4,454.21 0.04
September-21 4,307.54 4,445.54 0.028
October-21 4,605.38 4,460.71 0.048
November-21 4,567.00 4,667.39 0.048
December-21 4,766.18 4,674.77 0.033
January-22 4,515.55 4,573.82 0.173
February-22 4,373.79 4,435.98 0.288
March-22 4,530.41 4,391.27 0.493
April-22 4,131.93 4,391.30 0.808
May-22 4,132.15 4,040.36 1.03
June-22 3,785.38 3,898.95 1.6
July-22 4,130.29 3,911.73 2.298
August-22 3,955.00 4,158.56 2.86
September-22 3,585.62 3,850.52 3.18
October-22 3,871.98 3,726.05 3.975
November-22 4,080.11 3,917.49 4.253
December-22 3,839.50 3,912.38 4.26