Case Study 2_alex Sharpe 271h1s

Case Study: Alex Sharpe’s Portfolio

1. Estimate and compare the returns and variability (i.e. annual standard deviation over thepast five years) of Reynolds and Hasbro with that of the S&P 500 Index. Which stock appears tobe riskiest? Reynolds appears to be the riskiest stock based on the returns and variability .it holdingthe highest average return out of two at 1.87%. With their higher return rate over the three theyalso hold the highest standard deviation of 9.3%.highest standerd deviation shows reynolds aremore risky.

2. Suppose Sharpe’s position had been 99 percent of equity funds invested in the S&P 500and either one per cent in Reynolds over one percent in Hasbro. Estimate the resulting portfolio position. How does each stock affect the variability of the equity investment? How does thisrelate to your answer in question 1 above?

Weight: .99 in S&P 500 Alternative: .01 in Reynolds or Hasbro Average Returns: S&P 500 = 0.57% Reynolds= 1.87% Hasbro = 1.18 %

Portfolio Return: Weight * Return + Weight2 * Return2

Choosing Reynolds Portfolio Return = .99(.57)+ .01(1.87) = .587 or 58.7%

Choosing Hasbro Portfolio Return = .99(.57)+ .01(1.18) = .580 or 58%

Reynolds stock fluctuates more than Hasbro’s so the return is higher to accommodate the increased variability that Reynolds offers. On the other hand, Hasbro is less variable than Reynolds therefore the return on the equity investment is lower since the risk is lower. In reviewing this information it confirms the answer I stated in question 1 regarding which stock appears to be the riskiest.

3. Perform a regression of each stock’s monthly returns on the Index returns to compute a “beta” for each stock. How does this relate to your answer in question 2 above?

Beta of Hasbro is greater than Reynolds that shows Hasbro stock is more positively correlated to benchmark and have the highest risk .in question 2 Reynolds more risky but due to less positively correlated the portfolio of Reynolds is less risky .

4. How might the expected return of each stock relate to its riskiness?

The higher the risk must equate to higher returns as we see Reynolds has higher the return and higher the stander deviation .

Question 5

How might the expected return of each stock relate to its riskiness? Expected return is basically a return where investor anticipate to get when they involved in investment and the expected return can be either in the form of profit or loss. Since expected return were mostly calculated based on historical data of the selected stock, the expected return calculated cannot guarantee the investor that the investment in the stock will give an exact return but rather it can be used by the investor as a benchmark to determine the best possible return that the investor can get. However, even though expected return can be an indicator that can be used by investor to access the best possible return, to rely on the expected return only is a dangerous step that an investor can take. This is where investor need to take into consideration of the risk that the he or she should bear when it comes to stock investment. Risk is also one of the indicator that can be used in order to determine on how much does the investor should be compensated based on the level of risk the investor undertake. As risk and return are interrelated with each other, by anticipating a high risk, the investor will also anticipate a higher expected return in order to compensate the risk taking. Expected return of each stock is related to its riskiness in term of acting as a benchmark in determine the best possible return that the investor can anticipate including with the possibilities of getting lowest risk. For example, stock A and Stock B might have the same expected return of 10 % but at the same time the risk of bearing each stock is different based on standard deviation where stock A have a standard deviation of 8% while stock B have a standard deviation of 15%. In this sense, it is a benefit for investor to invest in Stock A given that the expected return is the same but the degree of risk that the investor should bear is lower. This enable the investor to make a better decision that not only can give anticipation of a high expected return but at the same time can enjoy a much lower risk. Based on this case study, it can be seen that the Reynolds possess the highest risk with standard deviation of 8% as compared to Hasbro with the standard deviation of 7% and S&P 500 with a standard deviation of 3%, with this, it is anticipated that the expected return of Reynolds (1.87%) to be the highest as compared to S&P 500 (0.57%) and Hasbro (1.19%), due to it more risk. Even

though the risk between Reynolds and Hasbro only differ by 1%, the expected return of Reynolds is way higher than Hasbro by 0.68%. This prove that Expected return of each stock is related to its riskiness in term of acting as a benchmark to determine the best possible return that the investor can anticipate including with the possibilities of getting lowest risk.

Standard Deviation Expected Return

S&P 500 3% 0.57%

Reynolds 8% 1.87%

Hasbro 7% 1.19%

The expected return of each stock relates to its riskiness because both can be used as indicators to determine the best possible return, with the least possible risk. Generally over time riskier investments will have higher returns as compensation to investors taking greater risks. The best way to reduce this risk is to hold assets over time and diversify portfolios with low-correlation assets to ensure that the money is not all in one place. Taking these factors in may allow individuals to hold riskier stock with higher returns, while also holding less risky stock that may not have the same pay out.

5. In what stock(s) (if any) should Sharpe invest?

We would recommend that Sharpe invest in Reynolds, as long as the portfolio’s is well diversified by combining it with S&P 500. This would be the best choice because a more diversified portfolio can eliminate risk, instead of a portfolio based on one stock. Choosing either Hasbro or Reynolds on their own would be unwise and Sharpe would benefit more, while taking less risk if he invests in both Reynolds and S&P 500