You Plan to Invest in Stock X,Stock Y,or Some Combination $\sigma$

question 24

Essay

You plan to invest in Stock X,Stock Y,or some combination of the two.The expected return for X is 10% and $\sigma$ _X = 5%.The expected return for Y is 12% and $\sigma$ _Y = 6%.The correlation coefficient,r_XY,is 0.75.
a.
Calculate r_p and $\sigma$ _p for 100%, 75%, 50%, 25%, and 0% in Stock X.
b.
Use the values you calculated for r_p and $\sigma$ _p to graph the attainable set of portfolios. Which part of the attainable set is efficient? Also, draw in a set of hypothetical indifference curves to show how an investor might select a portfolio comprised of Stocks X and Y. Let an indifference curve be tangent to the efficient set at the point where r_p = 11%.
c.
Now suppose we add a riskless asset to the investment possibilities. What effects will this have on the construction of portfolios?
d.
Suppose r_M = 12%, $\sigma$ _M = 4%, and r_RF = 6%. What would be the required and expected return on a portfolio with $\sigma$ _P = 10%?
e.
Suppose the correlation of Stock X with the market, r_XM, is 0.8, while r_YM = 0.9. Use this information, along with data given previously, to determine Stock X's and Stock Y's beta coefficients.
f. What is the required rate of return on Stocks X and Y? Do these stocks appear to be in equilibrium? If not, what would happen to bring about an equilibrium?

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Definitions:

Subsidiary

A company that is controlled by another company, known as a parent company, through the ownership of more than half of its voting stock.

Stock Dividend

A distribution of extra shares to shareholders, as opposed to a cash payment, as a form of dividend.

Common Stock

A type of equity security that represents ownership in a corporation, usually carrying voting rights and potential dividends.

Consolidation Process

The procedure of combining the financial statements of two or more entities into one, usually for a parent company and its subsidiaries.