Bond Valuation Share JAY and KAY Returns â€Myassignmenthelp.Com

Questions: Consider shares in two companies, JAY and KAY, as follows: Expected Return E(R) Standard Deviation s Correlation Coefficient r Share JAY 12% 18% 0.3 Share KAY 24% 32% a) Calculate the covariance between Share JAY and KAY returns. b) What is the expected return and standard deviation of returns on a portfolio comprising 35% in Share JAY and 65% in Share KAY? c) If you wanted to create a portfolio consisting only of these two shares, how much would you need to invest (weights) in each share so that your portfolio return would be equal to 15.6%? Note: do not round. d) Using the weights calculated in part c); calculate the variance and standard deviation of your portfolio. Answers: (a). Covariance between Share JAY and KAY returns: - To calculate the Covariance between Share JAY and KAY returns following formula is used:- = Standard Deviation of JAY * Standard Deviation of KAY *(Correlation Coefficient) = 18 *32 *(0.3) = 172.6 Hence, Covariance between Share JAY and KAY returns is 172.6 (b). (i) Expected Return: - Expected return means that the return the investor can expect in the future. It is not the accurate return but only expected return. Expected Return = Weight of JAY *(Expected Return) + Weight of KAY * (Expected Return) Expected Return = 0.35*(12) + 0.65 * (24) Expected Return = 19.8% Hence, the Expected Return is 19.8% (ii) Standard Deviation (WA2a2 )+ (WB2B2 )+2 (A*WA*b *WB)* Correlation Coefficient (0.35*0.35*18*18)+(0.65*0.65*32*32)+2(18* 0.35*32*0.65*-0.3) 39.69+32.64 -78.624 393.706 = 19.84 (c). If a portfolio is to create consisting only of these two shares, and to make the portfolio return equal to 15.6% then the investment is to be made of :- Let assume the weight of JAY is W, then the Weight of KAY WILL BE 1-W Desired Portfolio Return = 15.6% 15.6% = W*12%+ (1-W)* 24% 0.156 = 0.12W +0.24- 0.14 W 0.156 -0.24 =-0.12W 0.084 = 0.12W 0.084 / 0.12 = W 0.7 =W Expected weight which is earned is 15.6% Then weight of JAY (W) will be 70% Weight of KAY (1-W) will be 30%. (d). (i) Basis on the above calculation revised Standard Deviation is:- New Weight Standard Deviation JAY 70% 18 KAY 30% 32 = (0.70 * 0.70 *18 *18) + (0.30 * 0.30 * 32 * 32) + 2 (0.70 *18*0.30 *32 *- 0.3) = 158.76 + 92.16 -36.288 = 214.632 = 14.65 (ii) Variance is the square of standard deviation Variance = () 2 = (14.65) 2 Variance = 214.62.