Compare and contrast the Markowitz Portfolio Theory (MPT) with the Capital Asset Pricing Model (CAPM) with reference to the following aspects: Risk measurement; Risk-return graphical presentation – Capital Market Line (CML) versus Security Market Line (SML): Usage in portfolio management.
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- a) Explain the practical relevance of the mean-variance model of portfolio selectionQUESTION ONE (1) Assume that an officer of ZED Bank wants to execute a transaction with the following characteristics using the risk-adjusted return on capital (RAROC) model: ▪ Probability of default (PD) = 45 basis points ▪ Loss given default (LGD) = 50% ▪ Exposure at default (EAD) = US$ 2.0 million ▪ The risk-free rate of return is 6% This is a loan to an agricultural company and the bank’s economic capital (EC) model delivers the following charge for the firm:EC of exposure = 5% of EAD, which is US$ 100,000. Assume that the bank has set a RAROC hurdle rate of 15% and this transaction has a net profit of US$ 12,000 before other adjustments. Required: Compute the bank’s risk-adjusted rate of return on the loan to an agricultural company? Now assume that the bank could also have made a loan for the same amount and net profit of US$ 12,000 before other adjustments to a chemical manufacturing firm, and that the EC = 2.5% in this case. Which loan between the two should the bank…Please do not give solution in image formate thanku Question 1- The recent covid19 pandemic had shocked the global economy and investors were scrambling to assess its impact on the market. How would you apply what we learned in the class on economic analysis to tackle this task? Question 2- Compare the two methods of factor portfolio construction and discuss the pro and cons of each method.
- A policy portfolio has 50% allocated to UK equity and 50% to a global developed market. The manager has invested 55% in the UK equity, 35% in global developed markets and 10% in emerging markets. The returns of the markets were as follows: UK equity 15% Global developed market 7% Emerging market 5% Calculate and explain the contribution to the portfolios return from the asset managers allocation decisionSuppose stock returns can be explained by the following three-factor model: R=RF+ B1F+B2F2-B3F3 Assume there is no firm-specific risk. The information for each stock is presented here: ẞ1 B2 ẞ3 Stock A 1.75 Stock B .82 Stock C .83 .75 $.50 1.35 -.70 -.33 1.44 The risk premiums for the factors are 7.1 percent, 6.3 percent, and 6.7 percent, respectively. You create a portfolio with 20 percent invested in Stock A, 20 percent invested in Stock B, and the remainder in Stock C. The risk-free rate is 4.2 percent. What is the beta for each factor for the return on your portfolio? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) Factor F1 Factor F2 Factor F3 What is the expected return on your portfolio? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Expected return %Identify two (2) derivative investment products and how they allow investors to hedge against risk while creating unnecessary risk to the global economy.
- b) You need to analyse the type of investment skills the fund managers have employed and suggest how improve the funds's performances in the future. Below is the historical performance for two (2) different funds, the Kuala Lumpur composite Index (KLCI) and the 30-days Malaysia Treasury bill. Employ the data and analyse according to the questions below: Investment fund Average rate of return Standard deviation Beta CIMB Small cap fund 25.5% 18% 1.45 Public Bank fund 20% 13% 0.8 KLCI 18% 15% 30 days-T-Bill 2.4% 0% i) Calculate the fama overall performance measure for both funds Compute the expected return to risk for both fund ii) ii) Compute the measure of selectivity, diversification, and net selectivityProblem 4: Recall the following portfolio allocation problem: an individual with initial wealth wo has to choose an allocation between a safe asset (with a zero rate of return) and a risky asset with a random rate of return & € [−1, 1], where E[8] > 0. If the individual invests & dollars in the risky asset, then final wealth is (wo-x)+x(1+5) = w₁ +x6. The individual chooses to maximize expected utility denoted by E[u(wo +xd)]. 1. Suppose the Bernoulli utility function is u(w) solute risk aversion is a constant. = -e. Show that ab- 2. Let x* (wo) denote the optimal amount of investment in the risky asset. Show that for the utility function of Part a., da = 0, i.e. the amount of investment in the risky asset is independent of initial wealth. Explain this result. dwo 3. Now suppose that the utility function is u (w) = aw - bw², where a, b > 0. The parameters a and b are such that marginal utility of wealth is positive for all w. What can we say about in this case? Explain your result.QUESTION 2 Elizabeth has decided to form a portfolio by putting 30% of her money into stock 1 and 70% into stock 2. She assumes that the expected returns will be 10% and 18%, respectively, and that the standard deviations will be 15% and 24%, respectively. Describe what happens to the standard deviation of the portfolio returns when the coefficient of correlation ρ decreases. The standard deviation of the portfolio returns decreases as the coefficient of correlation decreases. The standard deviation of the portfolio returns increases as the coefficient of correlation increases. The standard deviation of the portfolio returns decreases as the coefficient of correlation increases. The standard deviation of the portfolio returns increases as the coefficient of correlation decreases.
- compare and contrast the three portfolio management theories: a) Modern Portfolio Theory by Markowitz b) Active Portfolio Management by Grinold & Kahn c) Equilibrium Approach by Black-LittermanPerson A, Person B and Person C own stock in the same company. All of them are loss averse and have the same value function: v(x) = x/2 for gains and v(x) = 2x for losses. The stock's price is shown in the graph below (a) 100 90 80 70 60 50 40 30 20 10 0 60 90 Stock Price 95 70 50 October November December January Feburary 80 March Person A bought the stock in November and uses the purchase price as their reference point. If you ask them, how much would they say that they lost in terms of value when the price dropped from £95 to £70? (b) Person B bought the stock in October and uses the peak price as their reference point. If you ask them, how much would they say that they lost in terms of value in January? (c) In January, which month should Person B rather use as reference point in order to maximize their value? (d) [ Person C bought the stock in March. They expect to derive a value of at least +5 in April as compared to their reference point of the purchase price. What is the minimum…Which statement about portfolio diversification is CORRECT? i) Typically, as more securities are added to a portfolio, total risk would be expected to decrease at an increasing rate.ii) Proper diversification can reduce or eliminate total risk.iii) The risk-reducing benefits of diversification do not occur meaningfully until at least 50-60 individual securities have been purchased.iv) Because diversification reduces a portfolio's total risk, it necessarily reduces the portfolio's expected return.