1) If you can invest two stocks A and B. Stock A offers a high expected return and has a very large standard deviation. Stock B has both small expected return and small standard deviation. The price...

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1) If you can invest two stocks A and B. Stock A offers a high expected return and has a very large standard deviation. Stock B has both small expected return and small standard deviation. The price of A and B are not perfectly correlated. Your fund manager tells you that since you are very risk-averse you should only invest in Stock B because it has lower standard deviation. Do you agree? Please explain. 2) Stocks of small firms have earned abnormal returns, primarily in the month of January. Why is this effect called an “anomaly”? What would proponent of efficient market hypothesis say about this anomaly? 3) Suppose you can form portfolios using only two stocks. Stock H and stock M, with the following characteristics: ?(??)=17%, ?(??)=12%, ???=0.2, ??=30%, ??=20% a. Find the portfolio weight on stock H that gives you a two-stock portfolio with an expected return equal to 15%. (4 points) b. Find the portfolio weight on stock H that gives you a two-stock portfolio that has a standard deviation of 25% (Make sure that you invest in an efficient portfolio). (6 points) 4) There are three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a sure rate of 5%. The probability distributions of the risky funds are: The stock funds and Bond funds are independent (the correlation coefficient ???=0) a. Suppose you can only invest in two of the three mutual funds and you have $1000 to invest. You are a risk-averse investor and you want to have an expected return of 12%, which two funds would you pick and how would you allocate the $1000 into the two funds? (5 points) b. Use the formula below to compute the optimal portfolio weights. What is the Sharpe ratio of the best CAL? You manage $1000 for your client and your client wants an expected return of 10%. How much money do you invest in each of the three funds? (5 points) 5) Assume the CAPM holds and use the following information: a) What is the expected return of a portfolio with a Beta of 1.4? (3 points) b) What are the risk-free rate and the expected return of the market portfolio? (2 points) 6) Suppose investors can only choose to invest in one of 5 stocks (A through E) in the adjoining picture. Every risk averse investor would prefer: a) only stock A b) only stock C c) either stock A or stock C d) either stock A or stock B or stock C e) either stock A or stock E f) it doesn’t matter which stock they choose Answer: Steps: 7) The stock price of Alpha Inc. is currently $20. A financial analyst summarizes the uncertainty about next year’s holding period return on the stock by specifying three possible scenarios: The standard deviation of the holding period returns for Alpha Inc. is approximately ______. a) 7% b) 16% c) 22% d) 28% e) 37% Answer: Steps: 8) Stock A has an expected return of 10% and standard deviation of 10%. Stock B has a standard deviation of 20%. The correlation coefficient of the two stock returns is -1. The risk-free rate is 8%. What must be the expected return of Stock B? a) 3% b) 4% c) 6% d) 9% e) 12% Answer: Steps: