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.

S&P 500 Reynolds Hasbro

Standard Deviation 3% 8% 7%
Expected Return 0.57% 1.87% 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 account 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