1.

PROJECT FINANCE

In the project finance pro forma of section 3.9 it is assumed that the firm pays off its initial
debt of 1,000 in equal installments of principal over five years. Change this assumption and
assume instead that the firm pays off its debt in equal payments of interest and principal over
five years.
Sales growth
Current assets/Sales
Current liabilities/Sales
Costs of goods sold/Sales
Depreciation rate
Interest rate on debt
Interest paid on cash & marketable securities
Tax rate
Dividend payout ratio

15%
15%
8%
55%
10%
10.00%
8.00%
40%
0% <-- No dividends until all

Debt repayment table (essentially a loan table from Chapter 1): The principal amounts are

entered into the balance sheet and the interest is put into the profit and loss statement.

Year
1
2
3
4
5

Year
Income statement

Sales
Costs of goods sold
Interest payments on debt
Interest earned on cash & marketable securities
Depreciation
Profit before tax
Taxes
Profit after tax
Dividends
Retained earnings
Balance sheet
Cash and marketable securities

the plug:
=C39-C28-C32

Principal
at begin.
of year
1,000
836.20
656.03
457.83
239.82

1,150
(633)
(100)
(1)
(211)
206
(82)
124
124

(21)

=C39-C28-C32

Current assets
Fixed assets
At cost
Depreciation
Net fixed assets

200

=B31-$B$7*(C30+B30)/2

Total assets

Current liabilities
Debt
Stock
Accumulated retained earnings
Total liabilities and equity

FREE CASH FLOW CALCULATION

Year

2,000
2,000
2,200

2,211
(211)
2,000
2,152

100
1,000
1,100
2,200

92
836
1,100
124
2,152

Profit after tax

Add back depreciation
Subtract increase in current assets
Add back increase in current liabilities
Subtract increase in fixed assets at cost

Equity cash flow

RETURN ON EQUITY (ROE)

Data table: ROE as a function of initial

equity investment

124
211
28
(8)
(211)
100
1
244

Add back after-tax interest on debt

Subtract after-tax interest on cash & mkt. securities
Free cash flow
Note that the cash flow generated by depreciation
equals the increase in fixed assets at cost.

RETURN ON EQUITY (ROE)

Year

173

-1,100
15.08% <-- =IRR(B70:G70)

2,000

15.08%
11.40%

1,800
1,600
1,400
1,200
1,000
800

11.98%
12.70%
13.59%
14.73%
16.27%
18.42%

600

21.70%

400
200

27.37%

40.10%

<-- No dividends until all the debt is paid off

Debt
Of which:
payment
at end yr. Interest
263.80
100.00
263.80
83.62
263.80
65.60
263.80
45.78
263.80
23.98

Repaid
principal
163.80
180.18
198.19
218.01
239.82

1,323
(727)
(84)
(3)
(233)
276
(110)
166
166

1,521
(836)
(66)
(4)
(257)
358
(143)
215
215

1,749
(962)
(46)
(2)
(284)
455
(182)
273
273

(47)

(45)

(5)

2,011
(1,106)
(24) <-- {=-TRANSPOSE(E17:E21)}
5
(314)
571
(229)
343
343

119

198

228

262

2,443
(443)
2,000
2,151

2,700
(700)
2,000
2,184

2,985
(985)
2,000
2,257

106
656
1,100
289
2,151

122
458
1,100
504
2,184

140
240
1,100
777
2,257

166
233
(26)
14
(233)
84
3
240

215
257
(30)
16
(257)
66
4
270

273
284
(34)
18
(284)
46
2
305

<-- =IRR(B70:G70)

302
3,299
(1,299)
2,000
2,421
161
40 <-- =F47-$B$47/5
1,100
1,120
2,421

343
314
(39)
21
(314)
24
(5)
344

2,220 <-- =G34+G48+G49

<-- =B71

45%
40%
35%

ROE

30%
25%

20%

ROE as a Function of Initial

Equity Investment

ROE

20%
15%
10%
Equity investment

5%

0%
0

500

1000

1500

2000

2. MEGA Corporation is considering leasing an asset from BASIS A Corporation. Here are the relevant facts:
Asset cost $250,000; Depreciation schedule:Year1: 30%; Year 2: 22%; Year 3: 19.20%; Year 4: 11.52%; Year 5: 11.52%
years. Lease payment $50,000 per year, at the beginning of years 0, 1, , 5 Asset residual value =Zero; Tax rates MEG
carryforwards that prevent it from utilizing any additional tax shields) ;BASIS A: TC = 20%.Show that it will be advanta
the asset and for BI to purchase the asset in order to lease it out to MEGA.

Lessee's problem below, Lessor's problem in row 30

Lessee's problem

Asset cost
Interest rate
Lease rental payment
Annual depreciation
Tax rate

250,000
9%
50,000
30%

22%

-50,000

-50,000

-50,000

-250,000

0
0

0
0

200,000

-50,000

-50,000

0%

Year
After-tax cash flows from leasing

After-tax lease rental

After-tax cash flows from buying the asset

Asset cost
depreciation tax shield
net cash flow from buying

-250,000

differential cash flow

lease minus buy

7.93%

IRR of differential cash flow

decision??

lease

<-- =IF(B23<(1-B8)*B5,"lease","buy")

Lessor's problem

asset cost
interest rate
lease rental payment
annual depreciation
tax rate
year

250,000
8%
50,000
20%

32%

20%
0

after-tax cash flows from leasing

after-tax lease rental

-40,000

-40,000

-40,000

-250,000

10,000
10,000

16,000
16,000

210,000

-50,000

-56,000

after-tax cash flows from buying the asset

asset cost
depreciation tax shield
net cash flow from buying

-250,000

differential cash flow

lease minus buy

IRR of differential cash flow
decision??

6.20%
don't lease

<-- =IF(B50>(1-B35)*B32,"lease","don't lease")

relevant facts:
11.52%; Year 5: 11.52%; Year 6: 5.76%. Lease term 6
e =Zero; Tax rates MEGA:TC = 0% (MEGA has tax-loss
w that it will be advantageous both for MEGA to lease

19.20%

11.52%

11.52%

5.76%

-50,000

-50,000

-50,000

0
0

0
0

0
0

0
0

-50,000

-50,000

-50,000

19.20%

11.52%

11.52%

5.76%

","don't lease")

-40,000

-40,000

-40,000

9,600
9,600

5,760
5,760

5,760
5,760

2,880
2,880

-49,600

-45,760

-45,760

-2,880

BASIC LEVERAGED LEASE EXAMPLE

3. Your company is considering either purchasing or leasing an asset that costs $1,000,000. The asset, if purchased, will b
depreciated on a straight-line basis over 15 years to a zero residual value. A leasing company is willing to lease the asset
for $300,000 per year; the first payment on the lease is due at the time the lease is undertaken (i.e., year 0), and the
remaining five payments are due at the beginning of years 1-15. Your company has a tax rate tc = 40 percent and can
borrow at 10 percent from its bank. Reconsider the leveraged-leasing example. Show that if depreciation is straight line
over 15 years, then the MPM rate of return is equal to the IRR. Explain.

cost of asset
lease term
residual value
equity
debt
interest
annual debt payment
annual rent received
tax rate

1,000,000
15
300,000
200,000
800,000 15-year term loan, equal payments of interest &
10%
105,179
110,000
40%

year

0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
MPM
IRR

equity invested

rental or
salvage

-200,000
110,000
110,000
110,000
110,000
110,000
110,000
110,000
110,000
110,000
110,000
110,000
110,000
110,000
110,000
110,000
300,000
4.18% <-- Solved by Solver
4.18%

CALCULATING THE MULTIPLE-PHASES METHOD (MPM) RETURN--REQUIRES SOLVER

year

1
2

investment at
beginning of year

200,000
188,869

attribution of cash flow

cash flow

19,488
18,480

3
4
5
6
7
8
9
10
11
12
13
14
15
16
17

You score is:

178,281
168,358
159,239
151,079
144,054
138,356
134,205
131,843
131,541
133,601
138,360
146,192
157,511
172,780
0

17,373
16,154
14,813
13,339
11,717
9,933
7,970
5,811
3,436
824
-2,050
-5,211
-8,688
180,000

LEVERAGED LEASE EXAMPLE

that costs $1,000,000. The asset, if purchased, will be

ue. A leasing company is willing to lease the asset
the lease is undertaken (i.e., year 0), and the
ompany has a tax rate tc = 40 percent and can
example. Show that if depreciation is straight line

15-year term loan, equal payments of interest & principal

depreciation

66,667
66,667
66,667
66,667
66,667
66,667
66,667
66,667
66,667
66,667
66,667
66,667
66,667
66,667
66,667

principal
at start
loan
of year payment

800,000
774,821
747,124
716,657
683,144
646,280
605,728
561,122
512,056
458,082
398,711
333,403
261,565
182,542
95,617

105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179

interest

80,000
77,482
74,712
71,666
68,314
64,628
60,573
56,112
51,206
45,808
39,871
33,340
26,156
18,254
9,562

repayment
of
principal

25,179
27,697
30,467
33,513
36,865
40,551
44,606
49,067
53,973
59,371
65,308
71,839
79,023
86,925
95,617

CASH
FLOW

-200,000
19,488 <-- =(1-tax)*C17+tax*D17-(1-tax)*G1718,480
17,373
16,154
14,813
13,339
11,717
9,933
7,970
5,811
3,436
824
-2,050
-5,211
-8,688
180,000

<-- Solved by Solver

RETURN--REQUIRES SOLVER
attribution of cash flow
income
investment

8,357
7,892

11,131
10,588

Explanation: When all of the cash flows

from the lease are positive, the MPM return
will be the same as the IRR. When the depreciation

7,450
7,035
6,654
6,313
6,019
5,781
5,608
5,509
5,497
5,583
5,781
6,109
6,582
7,220

9,923
9,119
8,160
7,026
5,697
4,151
2,362
302
-2,060
-4,759
-7,831
-11,319
-15,269
172,780

is straight-line over the life of the asset, this

will be the case.

<-- =(1-tax)*C17+tax*D17-(1-tax)*G17-H17

positive, the MPM return

the IRR. When the depreciation

the life of the asset, this

BASIC LEVERAGED LEASE EXAMPLE

4.Your company is considering either purchasing or leasing an asset that costs $1,000,000. The asset, if purchased, will be
straight-line basis over 15 years to a zero residual value. A leasing company is willing to lease the asset for $300,000 per y
payment on the lease is due at the time the lease is undertaken (i.e., year 0), and the remaining five payments are due at
years 1-15. Your company has a tax rate tc = 40 percent and can borrow at 10 percent from its bank. In the leveraged-leas
the lowest lease rental so that the MPM is equal to the IRR (assume the original depreciation schedule).
To answer this question, you have to run the Solver macro found on the
This program can also be run by [ctr]+a.
cost of asset
lease term
residual value
equity
debt
interest
annual debt payment
annual rent received
tax rate

1,000,000
15
300,000
200,000
800,000 15-year term loan, equal payments of interest & principal
10%
105,179
150,000
40%

year

0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16

equity invested

rental or
salvage

-200,000
150,000
150,000
150,000
150,000
150,000
150,000
150,000
150,000
150,000
150,000
150,000
150,000
150,000
150,000
150,000
300,000

Start
Increase
MPM
IRR

120,000
2,000
31.34%
34.61% <-- =IRR(I19:I35,0)
0
Year

Investment at beginning of
year

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
Results
rent

120,000
122,000
124,000
126,000
128,000
130,000
132,000
134,000
136,000
138,000
140,000
142,000
144,000
146,000
148,000

200,000
188,745
134,129
91,502
56,694
26,637
-11,366
-56,096
-81,282
-86,585
-89,729
-90,499
-88,656
-83,939
-76,062
-64,708
-244,708

MPM

Cash flow

73,941
113,774
84,666
63,487
47,827
46,352
44,730
25,186
5,303
3,144
769
-1,843
-4,716
-7,877
-11,354
180,000

IRR( see Data Table in right)

31.34%
31.34%
31.34%
31.34%
31.34%
31.34%
31.34%
31.34%
31.34%
31.34%
31.34%
31.34%
31.34%
31.34%
31.34%

19.68%
20.90%
22.07%
23.19%
24.28%
25.34%
26.36%
27.35%
28.33%
29.28%
30.21%
31.12%
32.01%
32.89%
33.76%

150,000

31.34%

34.61%

AN EXPLANATION OF EXERCISE 2

The VBA program on this workbook runs the Solver for a number of different values of the lease rent. The starting
value is given in the cell "Start" (B40), and the increases are given by the cell "Increase" (B41).
Thus, for the values given in this particular case, [ctr]+a will find the MPM for rents of 120000,122000, 124000 ...
Note that the MPM <= IRR.
Here you can see that the smallest rent for which the MPM = IRR is 142,000 (this number is, of course, approximate).

Your score is:

0,000. The asset, if purchased, will be depreciated on a

to lease the asset for $300,000 per year; the first
remaining five payments are due at the beginning of
t from its bank. In the leveraged-lease example , find
eciation schedule).

payments of interest & principal

depreciation

142,800
244,900
174,900
125,000
89,200
89,200
89,200
44,800

principal
at start
of year

800,000
774,821
747,124
716,657
683,144
646,280
605,728
561,122
512,056
458,082
398,711
333,403
261,565
182,542
95,617

loan
payment

105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179
105,179

interest

80,000
77,482
74,712
71,666
68,314
64,628
60,573
56,112
51,206
45,808
39,871
33,340
26,156
18,254
9,562

repayment
of
principal

25,179
27,697
30,467
33,513
36,865
40,551
44,606
49,067
53,973
59,371
65,308
71,839
79,023
86,925
95,617

CASH
FLOW

-200,000
73,941
113,774
84,666
63,487
47,827
46,352
44,730
25,186
5,303
3,144
769
-1,843
-4,716
-7,877
-11,354
180,000
34.610324%

Income

62,686
59,158
42,040
28,679
17,770
8,349
0
0
0
0
0
0
0
0
0
0

Investment

11,255
54,616
42,626
34,808
30,057
38,003
44,730
25,186
5,303
3,144
769
-1,843
-4,716
-7,877
-11,354
180,000

Rent
IRR - MPM

11.66%
10.44%
9.27%
8.15%
7.06%
6.01%
4.98%
3.99%
3.02%
2.07%
1.14%
0.23%
-0.67%
-1.55%
-2.41%

120,000
122,000
124,000
126,000
128,000
130,000
132,000
134,000
136,000
138,000
140,000
142,000
144,000
146,000
148,000

IRR
34.610324%
0.19677891
0.20898373
0.22068342
0.23194365
0.2428185
0.25335297
0.2635848
0.27354594
0.28326367
0.29276142
0.30205948
0.31117553
0.32012504
0.32892167
0.33757749

-3.27%

the lease rent. The starting

120000,122000, 124000 ...

ber is, of course, approximate).

150,000

0.34610324

1 5. Innovation Fund and Index 500 Fund Returns

2 The Index 500 fund mimics the SP500 index; the Innovation Fund is an "aggressive" growth fu

Following are annual return statistics for two mutual funds from the Future
Generation family: see rows 5-32 Use Excel to graph the combinations of
standard deviation of return (x-axis) and expected return (y-axis) by varying
the percentage of SP 500 in the portfolio from 0% to 100%.
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45

Year Ended
31 December
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
Average
Standard deviation
Covariance of returns
Portfolio returns
Percentage of SP500
Percentage of Innivation Fund
Expected portfolio return
Variance of portfolio return
Standard dev. of port. return

SP 500
Index
45.45%
23.20%
39.80%
2.30%
14.10%
8.60%
30.50%
-3.10%
31.70%
16.60%
5.30%
16.00%
31.80%
8.70%

Innivation
Fund
21.00%
25.55%
33.40%
-0.45%
23.00%
17.50%
28.60%
-15.50%
15.00%
28.70%
7.40%
19.50%
18.40%
5.70%

19.35%
14.18%
0.0129

16.27%
12.68%

15%
85%
16.73%
1.53%
12.39%

0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9

Sigma
Exp. return
12.39% 16.73%
12.68% 16.27%
12.47% 16.58%
12.33% 16.89%
12.28% 17.20%
12.32% 17.50%
12.44% 17.81%
12.64% 18.12%
12.92% 18.43%
13.27% 18.74%
13.69% 19.05%

20.0%
19.5%
19.0%
18.5%
18.0%
17.5%
17.0%
16.5%
16.0%
12.0%

12.5%

13.0%

A
46

C
1

14.18%

D
19.35%

12.0%F

12.5% G 13.0%

1
is an "aggressive"
2
growth fund

3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
4513.0%

13.5%

14.0%

14.5%

13.0%H
46

13.5%I

14.0%
J

14.5%
K

FIVE STOCKS

2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43

Market cap
Date
2/25/2008
2/19/2008
2/11/2008
2/4/2008
1/28/2008
1/22/2008
1/14/2008
1/7/2008
12/31/2007
12/24/2007
12/17/2007
12/10/2007
12/3/2007
11/26/2007
11/19/2007
11/12/2007
11/5/2007
10/29/2007
10/22/2007
10/15/2007
10/8/2007
10/1/2007
9/24/2007
9/17/2007
9/10/2007
9/4/2007
8/27/2007
8/20/2007
8/13/2007
8/6/2007
7/30/2007
7/23/2007
7/16/2007
7/9/2007
7/2/2007
6/25/2007
6/18/2007
6/11/2007

Kroger
KR
17.34

Safeway
SWY
13.15

Merck
MRK
100.07

Glaxo
GSK
122.93

25.94
25.74
26.87
25.65
25.90
25.23
25.32
26.37
25.27
26.89
26.72
26.13
28.31
28.67
27.92
28.57
26.56
28.17
28.52
27.85
29.65
28.83
28.36
28.38
27.01
25.30
26.43
27.22
25.94
25.24
25.61
26.09
28.10
28.56
27.99
27.89
28.85
30.39

30.29
29.75
31.99
31.37
31.55
31.09
31.91
33.54
33.03
34.95
35.32
34.99
34.98
34.73
33.62
32.47
30.65
32.90
33.05
31.44
34.88
33.09
33.05
32.89
32.48
30.52
31.60
32.81
32.35
32.35
31.46
31.00
34.08
35.48
34.38
33.89
34.54
34.09

46.39
46.07
47.53
44.53
45.98
47.79
53.32
60.55
56.85
58.71
59.15
59.57
60.67
58.97
57.28
58.00
55.54
55.68
57.21
52.76
53.16
53.16
51.35
51.48
49.22
49.25
49.46
50.11
48.92
50.17
49.58
49.42
48.33
50.14
48.76
49.10
47.87
50.02

45.85
44.08
44.19
41.56
46.34
46.25
49.71
52.38
49.57
50.03
50.19
52.25
52.51
51.93
50.07
48.25
49.01
50.10
49.28
49.52
50.94
52.75
51.90
52.90
52.10
51.77
50.94
50.94
49.45
50.79
49.76
47.95
50.85
50.76
50.04
50.59
50.07
50.96

Ford
McDonalds
F
MCD
13.89
67.88

6.52
6.25
6.45
6.08
6.85
6.58
5.92
6.06
6.13
6.70
6.79
6.89
7.06
7.51
7.19
7.70
8.20
8.95
8.67
8.37
9.20
8.37
8.49
8.23
8.03
7.52
7.81
7.90
7.83
8.23
8.06
8.23
8.40
8.97
9.11
9.42
9.13
8.92

56.45
55.69
55.30
55.64
54.22
54.10
52.40
54.32
57.05
59.50
60.03
61.16
60.16
58.47
57.72
58.13
56.82
57.51
56.97
54.97
55.56
54.93
53.07
53.40
54.03
47.98
47.99
48.84
46.35
48.14
47.28
47.51
50.76
50.58
50.11
49.46
49.13
50.83

44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89

A
6/4/2007
5/29/2007
5/21/2007
5/14/2007
5/7/2007
4/30/2007
4/23/2007
4/16/2007
4/9/2007
4/2/2007
3/26/2007
3/19/2007
3/12/2007
3/5/2007
2/26/2007
2/20/2007
2/12/2007
2/5/2007
1/29/2007
1/22/2007
1/16/2007
1/8/2007
1/3/2007
12/26/2006
12/18/2006
12/11/2006
12/4/2006
11/27/2006
11/20/2006
11/13/2006
11/6/2006
10/30/2006
10/23/2006
10/16/2006
10/9/2006
10/2/2006
9/25/2006
9/18/2006
9/11/2006
9/5/2006
8/28/2006
8/21/2006
8/14/2006
8/7/2006
7/31/2006
7/24/2006

B
29.29
31.14
29.29
29.33
28.60
29.19
29.40
29.67
28.34
28.78
27.93
27.99
26.30
25.01
25.07
25.38
26.17
25.53
25.50
24.17
23.79
23.26
23.28
22.75
22.88
23.96
22.75
21.35
21.47
21.87
21.72
21.24
22.42
21.91
21.59
22.12
22.76
22.46
22.13
23.59
23.37
22.89
22.89
22.30
22.46
22.53

C
34.54
36.07
33.90
34.68
35.64
35.64
36.45
37.54
36.22
36.10
36.42
36.57
34.24
34.01
33.62
34.88
36.23
35.44
35.86
34.51
34.10
33.53
32.98
34.30
34.49
33.72
31.26
30.50
30.07
30.36
30.67
28.29
28.75
28.58
28.23
28.12
30.07
29.86
29.06
30.01
30.83
30.63
29.71
28.01
28.50
27.83

D
49.44
51.03
52.55
52.11
50.89
50.81
50.75
50.39
49.14
44.57
43.23
43.50
42.17
43.66
42.88
41.67
42.97
42.52
43.40
44.63
44.25
43.46
42.99
42.31
41.56
42.69
42.63
43.36
42.51
43.36
41.49
43.40
44.35
43.92
41.57
40.28
40.32
40.45
39.55
39.51
39.41
38.55
37.68
38.71
39.42
39.20

E
49.82
49.54
50.65
55.75
54.88
55.93
55.51
56.86
55.66
53.88
52.94
52.54
52.26
53.25
52.32
54.53
55.35
53.50
52.95
51.82
53.09
51.00
51.20
50.06
49.71
49.27
49.83
50.98
49.01
49.34
49.30
50.57
50.13
52.87
50.80
51.09
50.08
50.79
52.07
51.82
53.40
51.32
51.22
51.78
51.41
51.94

F
8.24
8.35
8.45
8.69
8.37
8.22
8.05
7.75
8.02
8.01
7.89
7.89
7.55
7.93
7.59
8.30
8.53
8.73
8.23
8.42
8.30
7.89
7.62
7.51
7.42
7.08
7.23
8.04
8.52
8.89
8.58
8.38
8.29
8.01
8.17
8.31
8.09
8.00
8.02
8.77
8.27
8.00
8.00
7.37
7.13
6.84

G
50.09
49.64
49.60
50.99
49.35
48.64
47.70
47.12
46.42
44.61
43.90
43.90
42.37
43.02
42.55
44.83
44.16
43.42
43.40
41.83
43.66
43.09
42.42
43.19
42.45
42.30
42.64
41.00
40.81
40.75
39.92
39.23
39.44
39.44
40.05
38.15
37.21
36.34
35.89
35.67
34.96
33.51
34.41
33.00
33.68
33.57

90
91

A
7/17/2006
7/10/2006

B
22.67
21.54

C
27.66
24.59

D
35.62
34.46

E
51.69
50.49

F
6.23
6.33

G
33.01
31.43

H
1

2
3 <-- This is in billions of dollars
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43

FIVE STOCKS

2
3 Market cap
4
5
6

7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40

Date
2/25/2008
2/19/2008
2/11/2008
2/4/2008
1/28/2008
1/22/2008
1/14/2008
1/7/2008
12/31/2007
12/24/2007
12/17/2007
12/10/2007
12/3/2007
11/26/2007
11/19/2007
11/12/2007
11/5/2007
10/29/2007
10/22/2007
10/15/2007
10/8/2007
10/1/2007
9/24/2007
9/17/2007
9/10/2007
9/4/2007
8/27/2007
8/20/2007
8/13/2007
8/6/2007
7/30/2007

Kroger
KR
17.34

Safeway
SWY
13.15

Merck
MRK
100.07

Glaxo
GSK
122.93

25.94
25.74
26.87
25.65
25.90
25.23
25.32
26.37
25.27
26.89
26.72
26.13
28.31
28.67
27.92
28.57
26.56
28.17
28.52
27.85
29.65
28.83
28.36
28.38
27.01
25.30
26.43
27.22
25.94
25.24
25.61

30.29
29.75
31.99
31.37
31.55
31.09
31.91
33.54
33.03
34.95
35.32
34.99
34.98
34.73
33.62
32.47
30.65
32.90
33.05
31.44
34.88
33.09
33.05
32.89
32.48
30.52
31.60
32.81
32.35
32.35
31.46

46.39
46.07
47.53
44.53
45.98
47.79
53.32
60.55
56.85
58.71
59.15
59.57
60.67
58.97
57.28
58.00
55.54
55.68
57.21
52.76
53.16
53.16
51.35
51.48
49.22
49.25
49.46
50.11
48.92
50.17
49.58

45.85
44.08
44.19
41.56
46.34
46.25
49.71
52.38
49.57
50.03
50.19
52.25
52.51
51.93
50.07
48.25
49.01
50.10
49.28
49.52
50.94
52.75
51.90
52.90
52.10
51.77
50.94
50.94
49.45
50.79
49.76

Ford
McDonalds
F
MCD
13.89
67.88

6.52
6.25
6.45
6.08
6.85
6.58
5.92
6.06
6.13
6.70
6.79
6.89
7.06
7.51
7.19
7.70
8.20
8.95
8.67
8.37
9.20
8.37
8.49
8.23
8.03
7.52
7.81
7.90
7.83
8.23
8.06

56.45
55.69
55.30
55.64
54.22
54.10
52.40
54.32
57.05
59.50
60.03
61.16
60.16
58.47
57.72
58.13
56.82
57.51
56.97
54.97
55.56
54.93
53.07
53.40
54.03
47.98
47.99
48.84
46.35
48.14
47.28

41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86

A
7/23/2007
7/16/2007
7/9/2007
7/2/2007
6/25/2007
6/18/2007
6/11/2007
6/4/2007
5/29/2007
5/21/2007
5/14/2007
5/7/2007
4/30/2007
4/23/2007
4/16/2007
4/9/2007
4/2/2007
3/26/2007
3/19/2007
3/12/2007
3/5/2007
2/26/2007
2/20/2007
2/12/2007
2/5/2007
1/29/2007
1/22/2007
1/16/2007
1/8/2007
1/3/2007
12/26/2006
12/18/2006
12/11/2006
12/4/2006
11/27/2006
11/20/2006
11/13/2006
11/6/2006
10/30/2006
10/23/2006
10/16/2006
10/9/2006
10/2/2006
9/25/2006
9/18/2006
9/11/2006

B
26.09
28.10
28.56
27.99
27.89
28.85
30.39
29.29
31.14
29.29
29.33
28.60
29.19
29.40
29.67
28.34
28.78
27.93
27.99
26.30
25.01
25.07
25.38
26.17
25.53
25.50
24.17
23.79
23.26
23.28
22.75
22.88
23.96
22.75
21.35
21.47
21.87
21.72
21.24
22.42
21.91
21.59
22.12
22.76
22.46
22.13

C
31.00
34.08
35.48
34.38
33.89
34.54
34.09
34.54
36.07
33.90
34.68
35.64
35.64
36.45
37.54
36.22
36.10
36.42
36.57
34.24
34.01
33.62
34.88
36.23
35.44
35.86
34.51
34.10
33.53
32.98
34.30
34.49
33.72
31.26
30.50
30.07
30.36
30.67
28.29
28.75
28.58
28.23
28.12
30.07
29.86
29.06

D
49.42
48.33
50.14
48.76
49.10
47.87
50.02
49.44
51.03
52.55
52.11
50.89
50.81
50.75
50.39
49.14
44.57
43.23
43.50
42.17
43.66
42.88
41.67
42.97
42.52
43.40
44.63
44.25
43.46
42.99
42.31
41.56
42.69
42.63
43.36
42.51
43.36
41.49
43.40
44.35
43.92
41.57
40.28
40.32
40.45
39.55

E
47.95
50.85
50.76
50.04
50.59
50.07
50.96
49.82
49.54
50.65
55.75
54.88
55.93
55.51
56.86
55.66
53.88
52.94
52.54
52.26
53.25
52.32
54.53
55.35
53.50
52.95
51.82
53.09
51.00
51.20
50.06
49.71
49.27
49.83
50.98
49.01
49.34
49.30
50.57
50.13
52.87
50.80
51.09
50.08
50.79
52.07

F
8.23
8.40
8.97
9.11
9.42
9.13
8.92
8.24
8.35
8.45
8.69
8.37
8.22
8.05
7.75
8.02
8.01
7.89
7.89
7.55
7.93
7.59
8.30
8.53
8.73
8.23
8.42
8.30
7.89
7.62
7.51
7.42
7.08
7.23
8.04
8.52
8.89
8.58
8.38
8.29
8.01
8.17
8.31
8.09
8.00
8.02

G
47.51
50.76
50.58
50.11
49.46
49.13
50.83
50.09
49.64
49.60
50.99
49.35
48.64
47.70
47.12
46.42
44.61
43.90
43.90
42.37
43.02
42.55
44.83
44.16
43.42
43.40
41.83
43.66
43.09
42.42
43.19
42.45
42.30
42.64
41.00
40.81
40.75
39.92
39.23
39.44
39.44
40.05
38.15
37.21
36.34
35.89

87
88
89
90
91
92
93
94
95

A
9/5/2006
8/28/2006
8/21/2006
8/14/2006
8/7/2006
7/31/2006
7/24/2006
7/17/2006
7/10/2006

B
23.59
23.37
22.89
22.89
22.30
22.46
22.53
22.67
21.54

C
30.01
30.83
30.63
29.71
28.01
28.50
27.83
27.66
24.59

D
39.51
39.41
38.55
37.68
38.71
39.42
39.20
35.62
34.46

E
51.82
53.40
51.32
51.22
51.78
51.41
51.94
51.69
50.49

F
8.77
8.27
8.00
8.00
7.37
7.13
6.84
6.23
6.33

G
35.67
34.96
33.51
34.41
33.00
33.68
33.57
33.01
31.43

KR

SWY

MRK

GSK

-0.22%
0.0013
3.54%

-0.25%
0.0014
3.78%

2
3 <-- This is in billions of dollars
4
Mean
5
Variance
6
Sigma

7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40

Number of
data points
Date
2/25/2008
2/19/2008
2/11/2008
2/4/2008
1/28/2008
1/22/2008
1/14/2008
1/7/2008
12/31/2007
12/24/2007
12/17/2007
12/10/2007
12/3/2007
11/26/2007
11/19/2007
11/12/2007
11/5/2007
10/29/2007
10/22/2007
10/15/2007
10/8/2007
10/1/2007
9/24/2007
9/17/2007
9/10/2007
9/4/2007
8/27/2007
8/20/2007
8/13/2007
8/6/2007
7/30/2007

-0.35%
0.0012
3.52%

0.11%
0.0009
3.01%

-0.03%
0.0023
4.79%

85 <-- =COUNT(J11:J95)
KR
-0.0077
0.0430
-0.0465
0.0097
-0.0262
0.0036
0.0406
-0.0426
0.0621
-0.0063
-0.0223
0.0801
0.0126
-0.0265
0.0230
-0.0730
0.0589
0.0123
-0.0238
0.0626
-0.0280
-0.0164
0.0007
-0.0495
-0.0654
0.0437
0.0295
-0.0482
-0.0274
0.0146

SWY

MRK

GSK

-0.0180
0.0726
-0.0196
0.0057
-0.0147
0.0260
0.0498
-0.0153
0.0565
0.0105
-0.0094
-0.0003
-0.0072
-0.0325
-0.0348
-0.0577
0.0708
0.0045
-0.0499
0.1038
-0.0527
-0.0012
-0.0049
-0.0125
-0.0622
0.0348
0.0376
-0.0141
0.0000
-0.0279

-0.0069
0.0312
-0.0652
0.0320
0.0386
0.1095
0.1272
-0.0631
0.0322
0.0075
0.0071
0.0183
-0.0284
-0.0291
0.0125
-0.0433
0.0025
0.0271
-0.0810
0.0076
0.0000
-0.0346
0.0025
-0.0449
0.0006
0.0043
0.0131
-0.0240
0.0252
-0.0118

-0.0394
0.0025
-0.0614
0.1089
-0.0019
0.0721
0.0523
-0.0551
0.0092
0.0032
0.0402
0.0050
-0.0111
-0.0365
-0.0370
0.0156
0.0220
-0.0165
0.0049
0.0283
0.0349
-0.0162
0.0191
-0.0152
-0.0064
-0.0162
0.0000
-0.0297
0.0267
-0.0205

F
-0.0423
0.0315
-0.0591
0.1192
-0.0402
-0.1057
0.0234
0.0115
0.0889
0.0133
0.0146
0.0244
0.0618
-0.0435
0.0685
0.0629
0.0875
-0.0318
-0.0352
0.0945
-0.0945
0.0142
-0.0311
-0.0246
-0.0656
0.0378
0.0115
-0.0089
0.0498
-0.0209

H
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86

I
7/23/2007
7/16/2007
7/9/2007
7/2/2007
6/25/2007
6/18/2007
6/11/2007
6/4/2007
5/29/2007
5/21/2007
5/14/2007
5/7/2007
4/30/2007
4/23/2007
4/16/2007
4/9/2007
4/2/2007
3/26/2007
3/19/2007
3/12/2007
3/5/2007
2/26/2007
2/20/2007
2/12/2007
2/5/2007
1/29/2007
1/22/2007
1/16/2007
1/8/2007
1/3/2007
12/26/2006
12/18/2006
12/11/2006
12/4/2006
11/27/2006
11/20/2006
11/13/2006
11/6/2006
10/30/2006
10/23/2006
10/16/2006
10/9/2006
10/2/2006
9/25/2006
9/18/2006
9/11/2006

J
0.0186
0.0742
0.0162
-0.0202
-0.0036
0.0338
0.0520
-0.0369
0.0612
-0.0612
0.0014
-0.0252
0.0204
0.0072
0.0091
-0.0459
0.0154
-0.0300
0.0021
-0.0623
-0.0503
0.0024
0.0123
0.0307
-0.0248
-0.0012
-0.0536
-0.0158
-0.0225
0.0009
-0.0230
0.0057
0.0461
-0.0518
-0.0635
0.0056
0.0185
-0.0069
-0.0223
0.0541
-0.0230
-0.0147
0.0243
0.0285
-0.0133
-0.0148

K
-0.0147
0.0947
0.0403
-0.0315
-0.0144
0.0190
-0.0131
0.0131
0.0433
-0.0620
0.0227
0.0273
0.0000
0.0225
0.0295
-0.0358
-0.0033
0.0088
0.0041
-0.0658
-0.0067
-0.0115
0.0368
0.0380
-0.0220
0.0118
-0.0384
-0.0120
-0.0169
-0.0165
0.0392
0.0055
-0.0226
-0.0758
-0.0246
-0.0142
0.0096
0.0102
-0.0808
0.0161
-0.0059
-0.0123
-0.0039
0.0670
-0.0070
-0.0272

L
-0.0032
-0.0223
0.0368
-0.0279
0.0069
-0.0254
0.0439
-0.0117
0.0317
0.0294
-0.0084
-0.0237
-0.0016
-0.0012
-0.0071
-0.0251
-0.0976
-0.0305
0.0062
-0.0311
0.0347
-0.0180
-0.0286
0.0307
-0.0105
0.0205
0.0279
-0.0086
-0.0180
-0.0109
-0.0159
-0.0179
0.0268
-0.0014
0.0170
-0.0198
0.0198
-0.0441
0.0450
0.0217
-0.0097
-0.0550
-0.0315
0.0010
0.0032
-0.0225

M
-0.0371
0.0587
-0.0018
-0.0143
0.0109
-0.0103
0.0176
-0.0226
-0.0056
0.0222
0.0959
-0.0157
0.0190
-0.0075
0.0240
-0.0213
-0.0325
-0.0176
-0.0076
-0.0053
0.0188
-0.0176
0.0414
0.0149
-0.0340
-0.0103
-0.0216
0.0242
-0.0402
0.0039
-0.0225
-0.0070
-0.0089
0.0113
0.0228
-0.0394
0.0067
-0.0008
0.0254
-0.0087
0.0532
-0.0399
0.0057
-0.0200
0.0141
0.0249

N
0.0209
0.0204
0.0657
0.0155
0.0335
-0.0313
-0.0233
-0.0793
0.0133
0.0119
0.0280
-0.0375
-0.0181
-0.0209
-0.0380
0.0342
-0.0012
-0.0151
0.0000
-0.0440
0.0491
-0.0438
0.0894
0.0273
0.0232
-0.0590
0.0228
-0.0144
-0.0507
-0.0348
-0.0145
-0.0121
-0.0469
0.0210
0.1062
0.0580
0.0425
-0.0355
-0.0236
-0.0108
-0.0344
0.0198
0.0170
-0.0268
-0.0112
0.0025

H
87
88
89
90
91
92
93
94
95

I
9/5/2006
8/28/2006
8/21/2006
8/14/2006
8/7/2006
7/31/2006
7/24/2006
7/17/2006
7/10/2006

J
0.0639
-0.0094
-0.0208
0.0000
-0.0261
0.0071
0.0031
0.0062
-0.0511

K
0.0322
0.0270
-0.0065
-0.0305
-0.0589
0.0173
-0.0238
-0.0061
-0.1176

L
-0.0010
-0.0025
-0.0221
-0.0228
0.0270
0.0182
-0.0056
-0.0958
-0.0331

M
-0.0048
0.0300
-0.0397
-0.0020
0.0109
-0.0072
0.0103
-0.0048
-0.0235

N
0.0894
-0.0587
-0.0332
0.0000
-0.0820
-0.0331
-0.0415
-0.0934
0.0159

O
1

2
3
4
5
6

7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40

MCD
-0.69%
0.0007
2.69%

MCD
-0.0136
-0.0070
0.0061
-0.0259
-0.0022
-0.0319
0.0360
0.0490
0.0420
0.0089
0.0186
-0.0165
-0.0285
-0.0129
0.0071
-0.0228
0.0121
-0.0094
-0.0357
0.0107
-0.0114
-0.0344
0.0062
0.0117
-0.1188
0.0002
0.0176
-0.0523
0.0379
-0.0180

41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86

O
0.0049
0.0662
-0.0036
-0.0093
-0.0131
-0.0067
0.0340
-0.0147
-0.0090
-0.0008
0.0276
-0.0327
-0.0145
-0.0195
-0.0122
-0.0150
-0.0398
-0.0160
0.0000
-0.0355
0.0152
-0.0110
0.0522
-0.0151
-0.0169
-0.0005
-0.0368
0.0428
-0.0131
-0.0157
0.0180
-0.0173
-0.0035
0.0080
-0.0392
-0.0046
-0.0015
-0.0206
-0.0174
0.0053
0.0000
0.0153
-0.0486
-0.0249
-0.0237
-0.0125

87
88
89
90
91
92
93
94
95

O
-0.0061
-0.0201
-0.0424
0.0265
-0.0418
0.0204
-0.0033
-0.0168
-0.0490

6. On the spreadsheet with this exam you will find the weekly stock prices and
market capitalizations of equity for five American stocks.
6.1. For each stock, compute the mean returns, standard deviation of returns.
6.2. Compute the variance-covariance matrix for the five stocks.
6.3. Suppose that the annual interest rate is 5%. Find an optimal portfolio. Give
the portfolio proportions and the portfolios annualized mean and annualized
standard deviation.
6.4. Is there an all positive portfolio on the efficient frontier?

KR
0.0013
0.0009
0.0004
0.0002
0.0004
0.0003

KR
SWY
MRK
GSK
F
MCD
Constant

SWY
0.0009
0.0014
0.0003
0.0003
0.0005
0.0004

MRK
0.0004
0.0003
0.0012
0.0005
0.0002
0.0001

GSK
0.0002
0.0003
0.0005
0.0009
0.0003
0.0002

F
0.0004
0.0005
0.0002
0.0003
0.0023
0.0004

MCD
0.0003
0.0004
0.0001
0.0002
0.0004
0.0007

0.10% <-- =5%/52

Optimal
portfolio
-0.0419
<-- {=MMULT(MINVERSE(B4:G9),I4:I9-0.0620
B11)/SUM(MMULT(MINVERSE(B4:G9),I4:I90.4209
B11))}
-0.4061
-0.1013
1.1904

KR
SWY
MRK
GSK
F
MCD
Check

1.000 <-- =SUM(B14:B19)

Weekly statistics for optimal portfolio

Portfolio mean
-0.985% <-- =SUMPRODUCT(B14:B19,I4:I9)
Portfolio variance
0.0011 <-- {=MMULT(MMULT(TRANSPOSE(B14:B19),B4:G9),B14:B19)}
Portfolio sigma
3.272%
Annual statistics for optimal portfolio
Portfolio mean
-51.25% <-- =52*B24
Portfolio sigma
23.59% <-- =SQRT(52)*B26
All positive portfolio? Below I do a data table for the constant.
For all constants, the minimum portfolio position is negative
Constant
-0.2
-0.15
-0.1

-0.4061 <-- =MIN(B14:B19), data table header

-0.0019
-0.0014
-0.0006

-0.05
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
0.45
0.5
0.55
0.6
0.65
0.7
0.75
0.8
0.85
0.9
0.95
1
1.05
1.1
1.15
1.2
1.25
1.3
1.35
1.4
1.45
1.5
1.55
1.6

0.0022
-0.6039
-0.0078
-0.0056
-0.0048
-0.0044
-0.0041
-0.0040
-0.0038
-0.0038
-0.0037
-0.0036
-0.0036
-0.0036
-0.0035
-0.0035
-0.0035
-0.0035
-0.0034
-0.0034
-0.0034
-0.0034
-0.0034
-0.0034
-0.0034
-0.0033
-0.0033
-0.0033
-0.0033
-0.0033
-0.0033
-0.0033
-0.0033
-0.0033

<-- {=MMULT(TRANSPOSE('Ex 6-7 returns'!J11:O95-'Ex 6-7

returns'!J4:O4),'Ex 6-7 returns'!J11:O95-'Ex 6-7 returns'!J4:O4)/85}

,B4:G9),B14:B19)}

Means
-0.22% <-- {=TRANSPOSE('D:\for make up class\Exam
-0.25%
-0.35%
0.11%
-0.03%
-0.69%

E('D:\for make up class\ExamplesofFE\FMSU12009Final\FM-Benninga\Financial Modeling-Spring 2008\FM2008-Final\Result\[FM-Final Ex

FM2008-Final\Result\[FM-Final Exam copy-Solution.xls]Question 3-4 returns'!J4:O4)}

7. Refer to the same data and variance-covariance matrix as in the previous problem.
7.1. Compute the annualized expected returns for each stock under the following
assumptions:
These five stocks constitute a benchmark portfolio.
The risk-free rate is 4% annually.
The expected annual benchmark return is 12%.
7.2. Ms NNN is an eminent stock analyst. She thinks that the annualized return for
Kroger will be 12% annually, but has no opinions about any of the other stocks returns.
What should be her optimal portfolio holdings of the five stocks?

KR
SWY
MRK
GSK
F
MCD
Risk-free
Benchmark return
Parameter

KR

SWY

0.0013
0.0009
0.0004
0.0002
0.0004
0.0003

0.0009
0.0014
0.0003
0.0003
0.0005
0.0004

MRK
0.0004
0.0003
0.0012
0.0005
0.0002
0.0001

GSK
0.0002
0.0003
0.0005
0.0009
0.0003
0.0002

MCD

0.0004
0.0005
0.0002
0.0003
0.0023
0.0004

0.0003
0.0004
0.0001
0.0002
0.0004
0.0007

0.0008 <-- =4%/52

0.23% <-- =12%/52
3.13

KR
SWY
MRK
GSK
F
MCD

Benchmark
returns <-- Weekly, remember!
0.0019
0.0020
<-- {=B13*MMULT(B4:G9,K4:K9)+B11}
0.0027
0.0025
0.0019
0.0017

Benchmark return

0.0023 <-- {=SUMPRODUCT(B16:B21,K4:K9)}

Annual
returns
9.86%
10.36%
13.91%
12.76%
10.03%
8.88%

Weekly statistics for optimal portfolio

Portfolio mean
77.110% <-- =SUMPRODUCT(B16:B21,I4:I9)
Portfolio variance
0.0000 <-- {=MMULT(MMULT(TRANSPOSE(B16:B21),B4:G9),B16:B21)}
Portfolio sigma
0.028%
Annual statistics for optimal portfolio
Portfolio mean
4009.71% <-- =52*B26
Portfolio sigma
0.20% <-- =SQRT(52)*B28

All positive portfolio? Below I do a data table for the constant.

For all constants, the minimum portfolio position is positive
Constant
-0.2
-0.15
-0.1
-0.05
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
0.45
0.5
0.55
0.6
0.65
0.7
0.75
0.8
0.85
0.9
0.95
1
1.05
1.1
1.15
1.2
1.25
1.3
1.35
1.4
1.45
1.5
1.55
1.6

0.0017 <-- =MIN(B16:B21), data table header

0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017
0.0017

Asset
values

<-- {=MMULT(TRANSPOSE('Ex 6-7 returns'!J11:O95-'Ex 6-7

returns'!J4:O4),'Ex 6-7 returns'!J11:O95-'Ex 6-7 returns'!J4:O4)/85}

<-- =B16*52

17.34
13.15 <-- {=TRANSPOSE('Ex 6-7
100.07
data'!B3:G3)}
122.93
13.89
67.88

Benchmark
proportions
5.17%
3.92% <-- {=I4:I9/SUM(I4:I9)}
29.85%
36.67%
4.14%
20.25%

A FOUR-ASSET PORTFOLIO PROBLEM

8. This problem returns to the four-asset problem
Calculate the envelope set for these four assets and show that the individual assets all lie within this
envelope set. You should get a graph.
Mean returns

Variance-covariance

0.06
0.04
0.03
0.04
Constant

0.01
0.45
0.06
-0.04

0.03
0.06
0.77
0.02

0.05
-0.04
0.02
0.89

6%
10%
12%
15%

St. dev.
24.49%
67.08%
87.75%
94.34%

0.05

Portfolio 1

Both these portfolios are efficient

Portfolio 2

z
0.8069
0.1480
0.1093
0.1365
Mean
Variance
Covariance

Proportion of 1
Portfolio mean
Portfolio var.
Portfolio st. dev.

x
67.20%
12.33%
9.10%
11.37%

z
0.0132
0.1096
0.0789
0.1149

0.08062
0.06714
0.09672

0.12146
0.22571

-0.9
15.82%
53.84%
73.38%

y
4.17%
34.63%
24.91%
36.30%

0.054385 0.814807
0.538414

-0.330777755

Data table of portfolios

-1.4

-1.15
-0.9
-0.65
-0.4
-0.15
0.1
0.35
0.6
0.85
1.1
1.35

0.7338
88.42%
80.86%
73.38%
65.98%
58.72%
51.64%
44.82%
38.42%
32.67%
27.97%
24.94%
24.21%

15.82%
17.86%
16.84%
15.82%
14.80%
13.78%
12.76%
11.74%
10.72%
9.70%
8.67%
7.65%
6.63%

Efficient Frontier Showing the Individual Stocks

20%

Expected portfolio return

Proportion of 1

18%
16%
14%
12%
10%
8%

Stock B

6%
4%
2%

Stock A

25.97%
29.78%
34.98%
41.04%
47.64%
54.58%
24.49%
67.08%
87.75%
94.34%

Expected portfolio retu

1.6
1.85
2.1
2.35
2.6
2.85
Stock A
Stock B
Stock C
Stock D

2%

5.61%
4.59%
3.57%
2.55%
1.53%
0.51%

0%
20%

30%

40%

50%

60%

70%

Standard deviation of portfolio

6.00%
10.00%
12.00%
15.00%

assets all lie within this

Mean minus
constant
1%
5%
7%
10%

ontier Showing the Individual Stocks

Stock D
Stock C

70%

andard deviation of portfolio

80%

90%

100%

DOW-JONES 30 INDUSTRIALS, RETURN DATA for Dec. 93 - April 99

Dec-93
Jan-94
Feb-94
Mar-94
Apr-94
May-94
Jun-94
Jul-94
Aug-94
Sep-94
Oct-94
Nov-94
Dec-94
Jan-95
Feb-95
Mar-95
Apr-95
May-95
Jun-95
Jul-95
Aug-95
Sep-95
Oct-95
Nov-95
Dec-95
Jan-96
Feb-96
Mar-96
Apr-96
May-96
Jun-96
Jul-96
Aug-96
Sep-96
Oct-96
Nov-96
Dec-96
Jan-97
Feb-97
Mar-97
Apr-97
May-97
Jun-97
Jul-97
Aug-97
Sep-97
Oct-97
Nov-97

Index
3754.1
3978.4
3832
3636
3681.7
3758.4
3625
3764.5
3913.4
3843.2
3908.1
3739.2
3834.4
3843.9
4011.1
4157.7
4321.3
4465.1
4556.1
4708.5
4610.6
4789.1
4755.5
5074.5
5117.1
5395.3
5485.6
5587.1
5569.1
5643.2
5654.6
5528.9
5616.2
5882.2
6029.4
6521.7
6448.3
6813.1
6877.7
6583.5
7009
7331
7672.8
8222.6
7622.4
7945.3
7442.1
7823.1

1
AA
15.7954
18.1096
17.2228
16.3931
15.5634
16.2599
16.8354
18.0153
19.4385
19.6121
19.8209
18.9781
20.1406
18.3827
18.2366
19.4056
20.9838
21.8532
23.5568
26.7878
26.9548
24.9494
24.0647
27.726
25.06
26.4098
27.0641
29.8002
29.6812
29.4305
27.4008
27.8072
29.7848
28.2866
28.2627
30.6732
30.7334
33.2644
34.4627
32.8908
33.9192
35.7396
36.5891
42.9603
40.0402
39.9185
35.5372
32.8507

2
DIS
13.7441
15.2573
15.4995
13.562
13.7482
14.0312
13.4651
13.732
13.3674
12.5573
12.8253
14.1241
14.9358
16.5456
17.3587
17.3993
18.039
18.0797
18.0797
19.129
18.3541
18.7211
18.8331
19.6501
19.2708
21.0301
21.4393
20.9074
20.3288
19.9189
20.6157
18.2735
18.7252
20.7784
21.6782
24.3109
22.9534
24.0202
24.4734
24.0202
26.9937
27.0349
26.4984
26.7293
25.4063
26.6673
27.2878
31.4493

3
JNJ
20.5433
19.3988
18.4815
17.3876
19.0572
20.5245
19.8867
21.8
23.3911
24.1495
25.4911
25.0445
25.6897
27.2733
26.7622
28.0591
30.6527
31.3388
31.9904
34.0047
32.8557
35.2961
38.8078
41.4161
40.8783
45.8984
44.8547
44.2551
44.375
46.9028
47.6855
45.9997
47.615
49.5486
47.615
51.6752
48.2787
56.0421
55.9742
51.4719
59.503
58.6167
62.8908
60.6927
55.5878
56.5684
56.262
61.9439

4
PG
25.8483
27.1296
26.2177
24.3938
26.0828
25.8535
24.4777
25.7313
28.0968
27.5198
29.1826
29.0086
28.7765
30.3982
31.04
30.9233
32.7841
33.7225
33.7225
32.502
32.7379
36.3362
38.4158
41.0243
39.3644
40.019
39.0662
40.3763
40.4467
42.0622
43.3785
42.9491
42.7686
46.9191
47.8624
52.5762
52.0323
56.1255
58.3098
55.7007
61.2664
67.1738
68.8182
74.3627
65.075
67.5191
66.7107
74.7429

5
ALD
18.1703
18.0841
17.631
16.8519
15.9285
16.2939
16.0619
17.7435
17.4192
15.9045
16.1375
15.2823
15.9264
16.7461
17.8333
18.4807
18.6573
19.1005
21.0519
22.1163
21.0826
20.9639
20.1918
22.6059
22.6655
23.7988
26.6518
28.3288
27.7898
26.3332
27.4755
28.2571
29.8078
31.799
31.6179
35.4694
32.443
34.0773
35.1086
34.6226
35.1086
37.422
40.957
44.9796
40.3795
41.5717
35.2137
36.4466

6
EK
38.7584
38.4493
37.8293
39.0389
36.5096
41.5923
42.7014
42.9232
44.5038
46.2929
43.0502
41.0561
43.0864
44.2143
46.3827
48.429
52.2942
55.2699
55.4988
52.7524
53.2332
54.6159
57.7269
63.2775
62.1185
68.0291
66.6572
66.191
71.3185
69.7105
72.8738
69.9448
68.323
73.9773
75.0375
76.8253
75.9967
82.1521
85.4084
72.3235
79.1039
79.2844
73.4247
64.0972
62.9529
62.5316
57.6567
58.8035

7
JPM
56.8164
58.7615
55.7927
51.9298
50.8953
54.7228
51.8464
52.6826
55.0868
51.3587
52.4155
49.6679
48.0786
53.9679
55.2529
52.9051
56.9164
61.4697
61.4473
64.1856
63.857
68.452
68.2309
69.4473
71.7194
72.6131
73.1717
74.8961
75.9112
78.3927
77.0895
77.4312
79.7085
81.6862
79.3884
86.6264
90.551
95.5365
97.3916
91.8891
95.2794
100.774
98.4039
109.246
101.35
107.98
104.892
108.515

8
S
23.1166
23.991
20.1182
19.0158
20.7245
22.5034
21.3366
21.0032
21.2385
21.5187
22.1912
21.3663
20.8011
20.0097
22.4588
24.3399
24.7389
25.9474
27.3252
30.3641
30.3351
34.5516
31.8577
37.1143
36.7609
39.1173
42.983
46.1801
47.3642
48.413
46.2719
39.0159
42.0817
42.799
46.266
47.8049
44.2015
46.1233
52.3483
48.3679
46.3174
47.6131
52.0957
61.1822
55.2243
55.4067
40.7492
44.8024

9
AXP
24.3631
25.9542
23.2693
22.076
23.7819
25.2682
23.5532
24.4529
25.9523
28.0285
28.7025
27.5405
27.6359
29.5096
31.5003
32.6713
32.7656
33.4728
33.237
36.5355
38.3148
42.1107
38.7554
40.5441
39.4709
44.1223
44.0024
47.3595
46.7295
44.0799
42.9959
42.3635
42.3635
44.7843
45.7277
50.8356
55.187
60.6812
64.0999
58.4835
64.4607
68.1372
73.0392
82.3565
76.4564
80.5127
76.9136
77.7764

Dec-97
Jan-98
Feb-98
Mar-98
Apr-98
May-98
Jun-98
Jul-98
Aug-98
Sep-98
Oct-98
Nov-98
Dec-98
Jan-99
Feb-99
Mar-99
Apr-99

7908.3
7906.5
8545.7
8799.8
9063.4
8900
8952
8883.3
7539.1
7842.6
8592.1
9116.55
9181.43
9358.83
9306.58
9786.16
10878.4

34.3772
37.3081
36.018
33.7783
38.0428
34.165
32.4722
34.1342
29.5993
35.099
39.1774
36.8237
36.9786
41.4421
40.3666
41.0518
62.0449

32.795
35.4513
37.1305
35.4098
41.3787
37.6207
34.9009
34.3669
27.3813
25.323
26.9375
32.1875
30
33
35.1875
31.125
31.75

64.8351
65.8808
74.4217
72.5087
70.5958
68.4261
73.3181
76.5381
68.5905
77.7856
81.0163
81.0076
83.6248
84.8711
85.375
93.5
97.5

78.2992
77.1297
83.5264
83.0343
81.1268
82.7925
89.8872
78.6044
75.7573
70.4345
88.1321
87.0763
90.7407
90.6047
89.2338
97.6462
93.8125

38.1033
38.226
41.9341
41.3799
43.1656
42.2658
43.8724
43.0073
34.057
35.1116
38.6476
43.8271
44.1383
38.8467
41.375
49.1875
58.75

58.7429
63.2895
64.0829
63.3506
70.4912
70.1363
71.7946
82.4194
77.1713
75.9366
76.554
72.1615
71.5405
64.9577
66.1875
63.875
74.75

108.102
96.9092
114.447
129.559
126.605
119.792
113.822
122.634
90.9121
83.1117
92.5646
104.964
104.206
104.64
110.529
123.375
138

44.2523
44.9858
52.0514
56.4095
58.2509
60.9295
60.1902
50.025
44.9177
43.7421
44.4846
47.1769
42.2666
39.9046
40.625
45.1875
46

88.2357
82.7364
89.039
90.7691
101.244
101.677
112.927
109.576
77.4356
77.0633
87.7343
99.6542
102.082
102.687
108.302
117.75
135.375

10
GE
23.3923
24.0336
23.5039
22.4581
21.3913
22.3458
21.1025
22.7998
22.5169
21.9434
22.2854
20.9745
23.4447
23.6745
25.1686
25.0111
25.9374
26.8638
26.3037
27.5285
27.4702
29.9358
29.701
31.5206
34.0269
36.2717
35.6809
37.0249
36.7277
39.3427
41.2444
39.3134
39.7316
43.7155
46.4777
49.9605
47.739
49.972
49.6702
48.1623
53.8641
58.5954
63.0841
68.3252
60.9568
66.5744
63.2121
72.2599

11
KO
20.9735
19.211
20.0335
19.1848
19.716
19.0077
19.2745
21.0537
21.8247
23.1681
24.0019
24.4514
24.6307
25.109
26.3046
27.0696
27.9099
29.5905
30.723
31.6266
30.964
33.3667
34.757
36.7381
36.0106
36.5562
39.163
40.2569
39.6488
44.7569
47.803
45.7299
48.7785
49.7509
49.3842
50.1173
51.5878
56.7343
59.7977
54.7748
62.5121
67.3018
66.9477
68.0552
56.4255
60.2022
55.8845
61.8176

12
T
20.9341
22.6287
20.9341
20.5637
20.5637
21.9179
21.9486
22.0496
22.0496
21.9313
22.3374
19.9514
20.5399
20.3866
21.1019
21.2865
20.8752
20.8752
21.9376
21.8341
23.4381
27.3558
26.6277
27.4078
27.078
27.9667
26.6076
25.6972
25.7498
26.2227
26.2043
22.0834
22.1891
22.2208
20.8044
23.3306
25.9819
24.8377
25.1531
22.4413
21.3272
23.3963
22.5228
23.647
25.0521
28.6348
31.6277
36.1575

13
BA
21.625
21.625
23.375
22.25
22.5
23.1875
23.125
22.3125
22.75
21.625
21.9375
22.4375
23.5
22.25
23.0625
26.875
27.5
29.4375
31.3125
33.5
32
34.125
32.75
36.4375
39.1875
38.75
40.5625
43.3125
41.0625
42.625
43.5625
44.25
45.25
47.25
47.6875
49.6875
53.25
53.5625
50.875
49.3125
49.3125
52.6875
53.0625
58.6875
54.5
54.4375
48
53.125

14
GM
45.0597
50.2944
47.9845
44.3805
46.7489
44.4373
41.5437
42.4738
41.7106
38.9091
32.7874
31.8097
35.1472
32.4355
35.7471
36.9002
37.8437
40.5359
39.5859
41.1693
40.0453
39.8329
37.1774
41.4904
45.2331
45.0192
44.1771
45.9011
46.7631
47.8778
45.4894
42.3409
43.4287
42.0066
46.9292
50.7992
49.1463
52.0114
51.4604
49.2375
51.4604
51.4537
49.9964
55.4893
56.7362
60.5224
58.0359
55.5262

15
MCD
13.7669
14.6726
14.6684
13.7611
14.5172
15.0011
13.9999
13.1514
13.7276
12.8165
14.0313
13.817
14.243
15.8865
16.2202
16.647
17.0739
18.5111
19.122
18.8776
17.8725
18.7294
20.0759
21.8847
22.1299
24.6432
24.5535
23.5714
23.51
23.6691
22.9928
22.8084
22.8445
23.3371
21.9208
23.066
22.3876
22.4493
21.373
23.3497
26.4382
24.8726
23.9136
26.605
23.4582
23.6132
22.2187
24.0869

16
UK
20.0961
22.9028
21.6049
20.3606
23.8672
24.4934
24.1516
25.7465
31.5076
31.1639
30.2473
26.3993
27.091
23.5173
26.5746
28.4313
29.8239
27.2011
31.2871
32.4545
33.3309
37.3212
35.5608
37.3939
35.3885
39.7531
42.6474
47.0306
43.1213
41.0433
37.8312
39.9726
41.3415
43.6117
40.7441
44.272
39.2329
43.5522
45.5385
42.6471
48.0684
45.2292
45.5316
53.5737
49.8163
47.2679
44.3554
43.0558

17
C
12.8788
13.9554
12.299
11.6779
11.5122
10.891
10.684
10.9739
12.2576
10.891
11.5122
10.8496
10.7254
12.2162
12.8788
12.7959
13.707
13.9554
14.4938
15.6947
15.9018
17.5996
16.73
19.7115
20.7468
21.7821
22.1548
21.8649
20.3741
20.6226
22.6724
20.9953
21.5543
24.4117
26.9584
29.8158
30.0643
34.7023
35.5305
31.8035
36.7728
36.4415
41.7835
47.6639
42.0734
45.262
46.3801
50.5626

18
GT
40.952
43.3017
40.631
36.3659
35.019
34.9786
32.4963
32.1578
31.7785
30.3031
31.892
30.9319
30.7037
32.8723
33.8581
33.7433
34.8911
38.9218
37.9979
40.0768
37.1778
36.5969
35.3189
39.6298
42.4355
44.7735
44.5349
47.9425
49.0001
47.7035
45.342
41.7996
43.3386
43.8135
43.5761
46.3434
49.0906
52.0766
50.6647
50.1845
50.5447
56.3523
61.1187
62.4461
59.7486
66.6566
60.7181
59.1319

19
MMM
46.828
46.1821
45.7475
42.9799
42.5457
44.6825
43.4778
46.5443
48.6825
48.7929
48.9032
45.6392
47.5316
46.6411
49.1862
52.2182
53.5657
54.3169
51.9405
51.2616
49.8743
51.4721
51.9286
60.1258
61.0455
59.3211
60.3223
59.8591
60.9012
63.6441
64.3435
60.6134
64.5723
65.5115
71.7339
79.1315
78.4228
80.5488
87.4679
80.4562
82.7142
87.8566
97.7778
90.6059
86.437
88.9015
87.9998
94.2409

20
UTX
27.7036
30.1053
30.5833
27.941
28.6719
30.0639
29.1014
27.2896
29.0531
28.5964
28.7677
26.9392
28.9539
29.5871
30.7963
32.0723
33.9282
35.4396
36.4905
39.2346
39.1772
41.5267
41.7029
44.3294
44.8614
48.526
51.0455
53.3631
52.5312
52.2582
54.9458
53.7513
54.1274
57.7879
61.8085
67.6083
63.8723
67.2467
72.8436
73.3276
73.2066
78.1192
80.6705
82.1891
76.1604
79.0263
68.2943
73.4204

72.0761
76.1281
76.3737
84.996
84.0098
82.2224
89.6187
88.493
79.1552
79.0076
86.8898
89.7447
101.638
104.503
99.957
110.625
107.625

65.9594
64.043
67.8757
76.7505
75.2019
77.6797
84.8982
79.9334
64.6666
57.3608
67.2527
69.8842
66.8295
65.1463
63.7125
61.375
68.0625

39.8849
40.7388
39.6817
42.9822
39.305
39.7953
37.5561
39.8571
32.9541
38.6328
41.3185
41.1119
50.2994
60.2596
54.5325
53.2083
53.125

48.9375
47.625
54.25
52.125
50.0625
47.75
44.5625
38.8125
30.9375
34.3125
37.5625
40.625
32.625
34.6875
35.625
34
40.625

58.6689
55.9528
67.1049
65.9489
65.5839
70.4579
65.4952
70.8867
57.3827
54.1742
62.3806
69.5008
71.1793
89.2694
82.5625
87
89.0625

23.7144
23.404
27.1407
29.8454
30.7781
32.6882
34.3693
33.2797
28.1201
29.7724
33.4511
34.9912
38.3624
39.3612
42.4514
45.3125
42.375

41.8971
42.7509
45.526
49.1411
47.548
49.164
52.5483
47.2565
39.5737
42.6654
38.0897
44.5074
42.2696
39.348
44
45.1875
51.875

53.5442
49.2582
55.2834
59.6316
60.8118
60.8739
60.2527
66.8371
44.1025
37.2697
46.7114
49.9414
49.3824
55.9046
58.5845
63.6951
74.875

61.9941
61.0198
67.7762
74.1378
68.5102
70.65
63.3393
59.8989
48.4309
50.9018
53.2492
56.4017
50.1279
48.6992
46.0625
49.8125
57.1875

79.3703
80.7606
83.0319
88.5673
91.8521
90.6633
80.4468
73.5339
67.5285
72.6424
78.4957
79.9102
70.6039
77.0563
74.0625
70.75
89

71.3384
79.6051
87.8189
90.7687
96.7913
92.7796
91.299
94.6302
71.9086
75.7487
94.3917
106.609
108.163
118.793
123.573
135.107
143.836

21
CAT
20.0575
23.505
24.4644
25.3674
24.8367
24.1586
22.6045
24.5652
26.1519
24.5369
27.1602
24.6033
25.0578
23.4565
23.5707
25.3399
26.8286
27.6312
29.4656
32.4282
30.9306
26.2075
26.3289
28.4746
27.2568
30.0604
31.1694
31.7531
30.0991
30.8032
31.8006
31.1098
32.5266
35.5962
32.5829
37.5682
35.7284
37.0472
37.3455
38.3001
42.6778
46.8137
51.4891
53.9448
55.9316
51.958
49.5757
46.3714

22
HWP
18.6978
20.1771
21.4493
19.4914
19.0464
18.631
17.9285
18.4944
21.4428
20.8867
23.3967
23.3668
23.95
24.0999
27.577
28.9451
31.8005
31.7404
35.9233
37.5507
38.5754
40.3029
44.7743
40.1217
40.5905
41.0752
48.8298
45.7104
51.4166
51.7201
48.4987
42.8395
42.5961
47.5807
43.0667
52.5828
49.1579
51.4813
54.9052
52.2029
51.4676
50.4873
55.0435
68.8044
60.4495
68.5135
60.6957
60.2032

23
MO
14.7072
15.93
14.8063
13.5521
14.5895
13.1841
13.9778
14.9278
16.5563
16.8167
16.8511
16.4384
16.0502
16.6782
16.9574
18.49
19.1617
20.6112
21.2828
20.4959
21.3543
24.2147
24.4322
25.4472
26.4642
27.1973
29.0299
25.9849
26.6882
29.4274
31.097
31.2839
26.8361
27.1908
27.9861
31.2808
34.5841
36.3822
41.3938
35.2348
36.4698
40.7535
41.3688
42.1868
40.8429
39.2154
37.3873
41.0434

24
WMT
12.0448
12.7675
13.6709
12.4851
12.1835
11.3391
11.7217
12.0843
11.9234
11.3182
11.3787
11.2776
10.3075
11.0957
11.5201
12.4547
11.5433
12.0901
13.0271
12.9662
11.9553
12.0773
10.5524
11.7353
10.8796
9.9627
10.3906
11.2711
11.6999
12.68
12.4599
11.7847
12.976
12.976
13.0375
12.5455
11.2163
11.7093
13.0035
13.7756
13.8991
14.764
16.744
18.57
17.5796
18.169
17.3629
19.8743

25
CHV
36.1975
38.7942
36.346
35.2446
37.3425
36.8951
35.5168
37.6372
36.3278
35.6848
38.5782
37.7918
38.6581
38.6581
41.6687
41.9968
41.45
43.3881
40.9593
43.6089
43.1673
43.5019
41.7173
44.5198
47.2248
46.774
50.6061
51.061
52.7668
54.8215
54.1334
53.1012
54.5231
57.9959
60.8899
62.5583
60.6909
61.9748
60.7035
65.5268
64.468
66.4233
70.1596
74.9635
74.0371
79.4151
79.2956
77.2014

26
IBM
28.218
28.218
26.4076
27.2816
28.7175
31.4644
29.3418
30.9025
34.2112
34.7731
37.2079
35.335
36.7084
36.0217
37.5824
41.016
47.259
46.4474
47.9457
54.3759
51.629
47.1965
48.57
48.2578
45.6358
54.1886
61.2431
55.5621
53.814
53.3146
49.444
53.6892
57.1228
62.1796
64.427
79.5973
75.6643
78.3488
71.7937
68.5474
80.1592
86.4021
90.1479
105.63
101.26
105.88
98.3886
109.376

27
MRK
15.2539
16.1968
14.3664
13.3181
13.2621
13.6538
13.442
13.3855
15.4187
16.2382
16.2382
16.9789
17.5193
18.4958
19.4723
19.7272
19.8429
21.752
22.8808
24.0452
23.2301
26.2606
26.964
29.0156
30.9401
33.0617
31.2348
29.4945
28.6653
30.6198
30.7781
30.5995
31.2543
33.7237
35.4009
39.7736
38.3462
43.6436
44.366
40.7611
43.7245
43.4826
49.734
50.4936
44.63
48.8091
43.5894
46.3137

28
XON
26.2334
27.636
27.2536
26.4134
26.4134
25.9763
24.117
25.2857
25.5935
24.7332
27.0452
26.2905
26.4537
27.2158
28.151
29.363
30.6301
31.7916
31.4576
32.2927
30.9499
32.5256
34.3826
35.1771
36.8819
36.4841
36.4788
37.3965
39.0025
39.2587
40.2431
38.1006
38.1177
38.9361
41.45
44.5363
46.247
48.9014
47.6749
51.2416
53.8571
56.755
58.6708
61.5445
59.0011
61.7734
59.2422
59.2167

29
DD
20.9803
24.4045
23.3416
23.232
25.0402
27.3835
25.7272
26.2241
26.9319
25.819
26.5424
24.1885
25.1987
23.9079
25.4169
27.3982
29.8323
30.9758
31.3751
30.5765
30.0755
31.6281
28.6954
30.8523
32.4181
35.6078
35.7218
38.757
37.4729
37.5092
37.2152
37.9795
38.8929
41.7344
43.9247
44.9021
44.8425
52.2269
51.3607
50.7621
50.8219
52.3171
60.565
64.5987
60.3075
59.5816
55.045
58.9206

30
IP
30.0415
33.3117
32.3809
30.2631
29.0927
31.0809
29.7345
32.7079
34.815
35.4357
33.6301
32.4633
34.2226
32.293
34.8665
34.2388
35.1519
36.0791
39.3485
38.7749
37.8038
38.7849
34.1677
35.5673
35.2186
37.8919
33.465
36.9753
37.3263
37.5459
34.7211
35.6627
37.8932
40.2616
40.38
40.4943
38.5887
38.946
39.8925
37.3768
40.4915
46.1264
46.7888
54.0751
51.0568
53.2346
43.5556
46.2192

46.9155
46.6835
53.066
53.5523
55.6215
53.6677
51.6834
47.6539
41.2673
43.7237
44.432
48.8814
45.4825
43.1019
45.3409
45.7141
64.375

61.575
59.3538
66.1406
62.7019
74.5744
61.6507
59.4079
55.067
48.1836
52.6896
59.9678
62.2695
68.1583
78.1981
66.2875
67.8125
78.875

43.0775
39.5076
41.4115
40.0455
35.6627
35.9029
38.2225
42.5301
40.346
45.3604
50.1417
54.8616
52.9161
46.3634
38.698
35.1875
35.0625

19.597
19.7833
23.0132
25.2877
25.1633
27.4339
30.2744
31.458
29.4023
27.256
34.4599
37.5784
40.6763
42.9552
43.0176
46.0938
46.875

74.1326
71.9664
78.4815
77.9357
80.2404
78.0714
81.8589
80.7593
72.939
82.7873
80.2637
82.9833
82.3011
73.9284
76.875
88.75
99.75

104.507
98.6383
104.319
103.757
115.744
117.367
114.683
132.35
112.498
128.355
148.332
164.938
184.166
183.043
169.558
177.049
208.951

52.0161
57.598
62.5972
63.1279
59.342
57.6184
66.1257
61.089
57.3192
64.339
67.0702
77.033
73.4993
73.1256
81.223
80.125
70.375

59.3987
57.5785
62.2987
66.0855
71.3992
69.2832
70.1431
69.0375
64.7003
69.8294
70.8181
74.5711
72.7068
69.8482
66.5625
70.5625
83.0625

58.4342
55.0898
59.9518
66.4909
71.1966
75.8064
73.3512
60.8907
57.1733
55.568
57.0498
58.4921
52.7174
50.8546
51.3125
58.0625
70.6875

41.9622
44.4556
45.6029
45.8474
51.0434
45.2076
42.2593
43.8563
36.5762
46.091
45.9056
43.1786
44.5454
39.3267
42
42.1875
56.25

DOW-JONES 30 INDUSTRIALS, RETURN DATA for Dec. 93 - April 99

9. Using the data base of the DJ IndustrialsFor American Airlines (AA), Procter & Gamble (PG), and General
Electric (GE)compute:
a. The average monthly returns
b. The covariances of the monthly returns: AA,AA = Covariance(RAA, RAA), PG,PG = Covariance(RPG, RPG), GE,GE
(RGE,RGE)these are equal to the variance of AA, PG, and GE respectively. AA, GE = Covariance (RAA, RGE), AA
Covariance (RAA, RPG),PG, GE = Covariance(RPG, RGE).
c. What are the monthly expected return and monthly standard deviation of a portfolio which is invested in the t
respectively:0,2 and 0,4 and 0,4?
Means

AA
PG
GE
0.031168 0.02253 0.03143

Variance-covariance matrix
AA
PG
AA
0.019579 0.001062
PG
0.001062 0.005990
GE
0.001512 0.001351
Return data
AA
PG
Dec-03
Jan-04
Feb-04
Mar-04
Apr-04
May-04
Jun-04
Jul-04
Aug-04
Sep-04
Oct-04
Nov-04
Dec-04
Jan-05
Feb-05
Mar-05
Apr-05
May-05
Jun-05
Jul-05
Aug-05
Sep-05
Oct-05
Nov-05
Dec-05
Jan-06
Feb-06
Mar-06
Apr-06
May-06
Jun-06
Jul-06
Aug-06

0.101256
-0.04897
0.122094
-0.19467
0.044752
0.035394
0.070084
0.079
0.060509
-0.03851
-0.04252
0.061255
-0.08728
-0.00795
0.064102
0.569593
-0.28253
0.077957
0.137158
0.006234
-0.0744
-0.03546
0.152144
-0.09616
0.053863
0.024775
0.101097
-0.00399
-0.00845
-0.06897
0.014832
0.071118

-0.04998
-0.03361
0.04265
-0.04584
-0.00879
-0.05322
0.05121
0.09193
-0.02054
0.06042
-0.00596
-0.008
0.05636
-0.22835
0.3183
0.06017
0.02862
0
-0.03619
0.00726
0.10991
0.05723
0.0679
-0.04046
0.01663
-0.02381
0.03354
0.00174
0.03994
0.03129
-0.0099
-0.0042

GE
0.001512
0.001351
0.005003

GE
0.30208
-0.02204
-0.04449
-0.0475
0.04462
-0.05564
0.08043
-0.01241
-0.02547
0.01559
-0.05882
0.20316
-0.06186
0.06311
-0.00626
0.03704
0.03572
-0.02085
0.04656
-0.00212
0.08976
-0.00784
0.06126
0.07951
0.06597
-0.01629
0.03767
-0.00803
0.0712
0.04834
-0.04682
0.01064

Part a. Average monthly returns.

Part b. Variance-covariance matrix.

Price data
AA
PG
16.4445 28.5569
18.1096 27.1296
17.2228 26.2177
19.3256 27.3358
15.5634 26.0828
16.2599 25.8535
16.8354 24.4777
18.0153 25.7313
19.4385 28.0968
20.6147 27.5198
19.8209 29.1826
18.9781 29.0086
20.1406 28.7765
18.3827 30.3982
18.2366 23.4569
19.4056 30.9233
30.4589 32.7841
21.8532 33.7225
23.5568 33.7225
26.7878 32.502
26.9548 32.7379
24.9494 36.3362
24.0647 38.4158
27.726 41.0243
25.06 39.3644
26.4098 40.019
27.0641 39.0662
29.8002 40.3763
29.6812 40.4467
29.4305 42.0622
27.4008 43.3785
27.8072 42.9491
29.7848 42.7686

GE
18.4578
24.0336
23.5039
22.4581
21.3913
22.3458
21.1025
22.7998
22.5169
21.9434
22.2854
20.9745
25.2356
23.6745
25.1686
25.0111
25.9374
26.8638
26.3037
27.5285
27.4702
29.9358
29.701
31.5206
34.0269
36.2717
35.6809
37.0249
36.7277
39.3427
41.2444
39.3134
39.7316

Sep-06
Oct-06
Nov-06
Dec-06
Jan-07
Feb-07
Mar-07
Apr-07
May-07
Jun-07
Jul-07
Aug-07
Sep-07
Oct-07
Nov-07
Dec-07
Jan-08
Feb-08
Mar-08
Apr-08
May-08
Jun-08
Jul-08
Aug-08
Sep-08
Oct-08
Nov-08
Dec-08
Jan-08
Feb-08
Mar-09
Apr-09

-0.0503
-0.00084
0.085289
0.001963
0.082353
0.036023
-0.04561
0.031267
0.053669
0.023769
0.174128
-0.06797
-0.00304
-0.10976
-0.0756
0.046468
0.085257
-0.03458
-0.06218
0.12625
-0.10193
-0.04955
0.051182
-0.13286
0.185805
0.116197
-0.06008
0.004207
0.120705
-0.02595
0.016974
0.716125

0.09705
0.0201
0.09849
-0.01034
0.07867
0.03892
-0.04475
0.09992
0.09642
0.02448
0.08057
-0.1249
0.03756
-0.01197
0.1204
0.04758
-0.01494
0.08293
-0.00589
-0.02297
0.02053
0.08569
-0.12552
-0.03622
-0.07026
0.25126
-0.01198
0.04208
-0.0015
-0.01513
0.09427
0.01499

0.10027
0.06319
0.07493
-0.04447
0.04678
-0.00604
-0.03036
0.11839
0.08784
0.0766
0.08308
-0.10784
0.09216
-0.0505
0.14313
-0.00254
0.05622
0.00323
0.1129
-0.0116
-0.02128
0.08995
-0.01256
-0.10552
-0.00186
0.09977
0.03286
0.13252
0.02819
-0.0435
0.10673
0.04443

28.2866
28.2627
30.6732
30.7334
33.2644
34.4627
32.8908
33.9192
35.7396
36.5891
42.9603
40.0402
39.9185
35.5372
32.8507
34.3772
37.3081
36.018
33.7783
38.0428
34.165
32.4722
34.1342
29.5993
35.099
39.1774
36.8237
36.9786
41.4421
40.3666
41.0518
70.45

46.9191
47.8624
52.5762
52.0323
56.1255
58.3098
55.7007
61.2664
67.1738
68.8182
74.3627
65.075
67.5191
66.7107
74.7429
78.2992
77.1297
83.5264
83.0343
81.1268
82.7925
89.8872
78.6044
75.7573
70.4345
88.1321
87.0763
90.7407
90.6047
89.2338
97.6462
99.11

43.7155
46.4777
49.9605
47.739
49.972
49.6702
48.1623
53.8641
58.5954
63.0841
68.3252
60.9568
66.5744
63.2121
72.2599
72.0761
76.1281
76.3737
84.996
84.0098
82.2224
89.6187
88.493
79.1552
79.0076
86.8898
89.7447
101.638
104.503
99.957
110.625
115.54

Procter & Gamble (PG), and General

, PG,PG = Covariance(RPG, RPG), GE,GE = Covariance

y. AA, GE = Covariance (RAA, RGE), AA,PG =

of a portfolio which is invested in the three stocks

Part c. Expected return and standard deviation
of a nonequal-proportion portfolio:
Proportions:
Return
Sigma

0.16

0.22

0.52

2.63% <-- =MMULT(L8:N8,TRANSPOSE(B5:D5))

5.27% <-- =SQRT(MMULT(MMULT(L8:N8,B9:D11),TRANSPOSE(L8:N8)))

Note: Since the two formulas above use the array functions, they
must be entered with [ctrl]+[shift]+[enter].

Ex 10

10

Expected return
Variance of return
Standard deviation of return
Correlation

3%
5%
0.0025
0.0045
0.05 0.067082
0.44

Proportion of A
Portfolio expected return
Portfolio standard deviation

0.37

4.260% <-- =B8*B4+(1-B8)*C4

5.307% <-- =SQRT(B8^2*B5+(1-B8)^2*C5+2*B8*(1-B8)*B6*SQRT(B5)*SQ

Sigma for Correlation(A,B)

5.307%
0
Proportion
0.1
of A
0.2
0.3
0.4
0.5
0.572949
0.7
0.8
0.9
1

1
6.71%
6.54%
6.37%
6.20%
6.02%
5.85%
5.73%
5.51%
5.34%
5.17%
5.00%

0
6.71%
6.06%
5.46%
4.93%
4.49%
4.18%
4.05%
4.04%
4.22%
4.55%
5.00%

-1
6.71%
5.54%
4.37%
3.20%
2.02%
0.85%
0.00%
1.49%
2.66%
3.83%
5.00%

To graph: Line up all the sigmas, put expected returns in different columns:

corr = +1

Sigma for correlation = 1

6.71%
6.54%
6.37%

Page 65

5.00%
4.80%
4.60%

corr = 0

Ex 10

6.20%
6.02%
5.85%
5.73%
5.51%
5.34%
5.17%
5.00%
6.71%
6.06%
5.46%
4.93%
4.49%
4.18%
4.05%
4.04%
4.22%
4.55%
5.00%
6.71%
5.54%
4.37%
3.20%
2.02%
0.85%
0.00%
1.49%
2.66%
3.83%
5.00%

Sigma for correlation = 0

Sigma for correlation = -1

Page 66

4.40%
4.20%
4.00%
3.85%
3.60%
3.40%
3.20%
3.00%
5.00%
4.80%
4.60%
4.40%
4.20%
4.00%
3.85%
3.60%
3.40%
3.20%
3.00%

Ex 10

^2*B5+(1-B8)^2*C5+2*B8*(1-B8)*B6*SQRT(B5)*SQRT(C5))

Expected
return

5.00%
4.80%
4.60%
4.40%
4.20%
4.00%
3.85% <-- Note that proportion = 0.572949 gives sigma = 0 for corr = -1.
3.60% This proportion is determined by:
3.40%
prop(A) = sigma(B)/(sigma(A)+sigma(B))
3.20%
3.00%
6%

5%
corr = -1

4%
3%

Page 67

Ex 10

3%
2%

corr = +1
corr = 0

1%

corr = -1

0%
0%

2%

5.00%
4.80%
4.60%
4.40%
4.20%
4.00%
3.85%
3.60%
3.40%
3.20%
3.00%

Page 68

4%

6%

Ex 10

Page 69

Ex 10

corr = +1
corr = -1

8%

Page 70

UN-5H
A

KAZZINK AND KAZAKHMYS

11. KazZink and KazakhMys are two kazakh exploration firms. The following table (see rows 316) gives the end-of-year stock prices for each of the firms for the years 1995-2006 as well as the
dividends paid in the years 1995-2006.
a. For the decade 1995-2006 calculate the following:
1.Annual returns from each of the shares. (Don't forget the dividends!)
2.The mean, variance, and standard deviation of each stock's return.
3.The covariance and the correlation coefficient of the returns.
b. Graph the mean portfolio return (y-axis) against the standard deviation of the portfolio
return (x-axis) for portfolios of the two shares in which the weight of KazZink goes from 0 to
2 1.4.
1

3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37

KazZink
Stock price Dividend
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006

12.85
16.35
19.6
17.95
23.45
29.75
29.25
26.9
32.45
34.1
61.45
80.05

KazakhMys
Stock priceDividend

5.05
3.25
5.15
4.85
6.35
10.95
18.55
17.95
22.85
26.35
44.36
55.15

0.44
0.58
0.61
0.74
0.81
0.9
1.05
1.2
1.32
1.3
1.5

0.16
0.16
0.17
0.18
0.21
0.27
0.43
0.55
0.64
0.75
0.84

NOTE: you can also use discrete return

RETURN CALCULATION
KazZink
KazakhMys
1996
0.26744
-0.39268 <-- =LN((E6+F6)/E5)
1996
1997
0.21046
0.49094
1997
1998
-0.05452
-0.02557
1998
1999
0.29835
0.29743
1999
2000
0.26482
0.56388
2000
2001
0.01336
0.54158
2001
2002
-0.04546
-0.00921
2002
2003
0.22389
0.26515
2003
2004
0.08758
0.16652
2004
2005
0.60986
0.53764
2005
2006
0.28299
0.23283
2006
Mean return
19.63%
24.26% <-- =AVERAGE(C21:C31)
Mean return
Return variance 0.036632975 0.08896225 <-- =VAR(C21:C31)
Return variance
Standard deviation
19.14%
29.83% <-- =STDEV(C21:C31)
Standard deviation
Covariance
0.0172
<-- =COVAR(B21:B31,C21:C31)Covariance
Correlation
0.3318
<-- =CORREL(B21:B31,C21:C31)
Correlation

Page 71

UN-5H

38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61

Proportion of KazZink
Portfolio mean
Portfolio variance
Portfolio s. dev.

0.24
23.15%
5.98%
24.45%

<-- =B38*B32+(1-B38)*C32
<-- =B38^2*B33+(1-B38)^2*C33+2*B38*(1-B38)*B35
<-- =SQRT(B40)
S. dev.

Mean

Proportion

<-- Contains the data table header, which has been hidden
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
1.1
1.2
1.3
1.4

29.83%
27.48%
25.28%
23.26%
21.48%
20.00%
18.89%
18.22%
18.03%
18.35%
19.14%
20.35%
21.92%
23.77%
25.84%

24.26%
23.80%
23.33%
22.87%
22.41%
21.94%
21.48%
21.02%
20.55%
20.09%
19.63%
19.16%
18.70%
18.23%
17.77%

Page 72

Portfolio
Portfolio
Returns-KazZink
Returns--Pfizer
and
and
KazakhMys
Merck
27%
Mean return

25%
23%
21%
19%
17%
16%

21%
Standard deviation

UN-5H
H

owing table (see rows 3995-2006 as well as the

n of the portfolio
Zink goes from 0 to

2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
TE: you can also
19 use discrete returns
20 KazZink KazakhMys
21 0.30661
-0.32475
22 0.23425
0.63385
23 -0.05306
-0.02524
24 0.34763
0.34639
25 0.30320
0.75748
26 0.01345
0.71872
27 -0.04444
-0.00916
28 0.25093
0.30362
29 0.09153
0.18118
30 0.84018
0.71195
31 0.32710
0.26217
32 23.79%
32.33%
33 0.06281 0.12692031
34 25.06%
35.63%
35
0.0310
36
0.3818
37

<-- =(E6+F6)/E5-1

<-<-<-<-<--

=AVERAGE(I21:I31)
=VAR(I21:I31)
=STDEV(I21:I31)
=COVAR(H21:H31,I21:I31)
=CORREL(H21:H31,I21:I31)

Page 73

UN-5H
H

38
39
40
41
42
43
header, which44has been hidden
45
46
47
48
KazZink
and
and
KazakhMys
Merck
49Pfizer
50
51
52
53
54
55
56
57
58
26%
59
Standard deviation
60
61

31%

Page 74

12.In the following table you will find annual return data for six furniture companies
between the years 1982 and 1992. Use these data to calculate the variance-covariance
matrix of the returns in the next sheet.
Answer to Problem 1

La-Z-Boy
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992

mean
sigma

Kimball

Flexsteel

Leggett
& Platt

Herman
Shaw
Miller Industries

36.67%
122.82%
14.44%
21.39%
45.36%
20.19%
-8.94%
27.02%
-11.64%
20.29%
34.08%

0.20%
61.43%
63.51%
28.42%
-7.44%
48.27%
-11.28%
12.85%
2.42%
6.90%
22.21%

41.54%
195.09%
-38.38%
1.30%
21.89%
9.11%
12.65%
12.08%
-17.13%
3.62%
33.46%

21.92%
62.27%
-1.27%
81.17%
19.83%
-10.21%
13.77%
32.55%
-6.48%
50.12%
84.40%

26.13%
73.38%
45.15%
24.27%
10.73%
-11.92%
7.06%
-7.55%
1.31%
-5.54%
5.71%

22.50%
117.89%
7.80%
38.14%
54.48%
26.82%
-6.24%
123.03%
15.48%
19.92%
62.76%

29.24%
33.94%

20.68%
25.47%

25.02%
57.74%

31.64%
32.13%

15.34%
24.38%

43.87%
40.66%

excess return matrix

La-Z-Boy
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992

average

7.42%
93.58%
-14.81%
-7.85%
16.12%
-9.05%
-38.18%
-2.23%
-40.89%
-8.95%
4.84%
0.00%

Kimball

-20.48%
40.75%
42.83%
7.74%
-28.12%
27.59%
-31.96%
-7.83%
-18.26%
-13.78%
1.53%
0.00%

Flexsteel

16.52%
170.07%
-63.40%
-23.72%
-3.13%
-15.91%
-12.37%
-12.94%
-42.15%
-21.40%
8.44%
0.00%

transpose of excess return matrix

1982
1983
1984
La-Z-Boy
7.42%
93.58% -14.81%
Kimball
-20.48%
40.75%
42.83%

Leggett

Miller

Shaw

-9.73%
30.63%
-32.92%
49.53%
-11.81%
-41.86%
-17.87%
0.91%
-38.12%
18.48%
52.75%
0.00%

10.79%
58.04%
29.81%
8.94%
-4.61%
-27.26%
-8.27%
-22.89%
-14.03%
-20.88%
-9.63%
0.00%

-21.37%
74.02%
-36.07%
-5.73%
10.61%
-17.05%
-50.11%
79.16%
-28.39%
-23.95%
18.89%
0.00% this line included as check only!

1985

1986

1987

1988

1989

-7.85%
7.74%

16.12%
-28.12%

-9.05%
27.59%

-38.18%
-31.96%

-2.23%
-7.83%

Flexsteel
Leggett
Miller
Shaw

16.52%
-9.73%
10.79%
-21.37%

170.07%
30.63%
58.04%
74.02%

-63.40%
-32.92%
29.81%
-36.07%

Variance-covariance matrix
La-Z-Boy Kimball Flexsteel
La-Z-Boy
0.1152
0.0398
0.1792
Kimball
0.0398
0.0649
0.0447
Flexsteel
0.1792
0.0447
0.3334
Leggett
0.0492
0.0062
0.0775
Miller
0.0568
0.0349
0.0886
Shaw
0.0989
0.0269
0.1487

-23.72%
49.53%
8.94%
-5.73%

Leggett

0.0492
0.0062
0.0775
0.1033
0.0191
0.0597

-3.13%
-11.81%
-4.61%
10.61%

-15.91%
-41.86%
-27.26%
-17.05%

Miller

Shaw

0.0568
0.0349
0.0886
0.0191
0.0594
0.0243

0.0989
0.0269
0.1487
0.0597
0.0243
0.1653

-12.37%
-17.87%
-8.27%
-50.11%

-12.94%
0.91%
-22.89%
79.16%

Means

29.24%
20.68%
25.02%
31.64%
15.34%
43.87%

cluded as check only!

1990

1991

1992

-40.89%
-18.26%

-8.95%
-13.78%

4.84%
1.53%

-42.15%
-38.12%
-14.03%
-28.39%

-21.40%
18.48%
-20.88%
-23.95%

8.44%
52.75%
-9.63%
18.89%

13. For the given variance- covariance matrix below : Supposing that the standard deviation of
the market index is 18 percent,calculate the variance-covariance matrix using the single-index
model.
Single-Index Model
variance-covariance matrix calculated from return data :
La-Z-Boy Kimball

0.1152
0.0398
0.1792
0.0492
0.0568
0.0989

La-Z-Boy
Kimball
Flexsteel
Leggett
Miller
Shaw

market variance

0.0398
0.0649
0.0447
0.0062
0.0349
0.0269

Flexsteel Leggett

Miller

Shaw

0.1792
0.0447
0.3334
0.0775
0.0886
0.1487

0.0492
0.0062
0.0775
0.1033
0.0191
0.0597

0.0568
0.0349
0.0886
0.0191
0.0594
0.0243

0.0989
0.0269
0.1487
0.0597
0.0243
0.1653

0.0324
equity betas on both borders
0.8
0.95
0.65
0.85
0.85
1.4

0.8

0.95

0.65

0.85

0.85

1.4

0.0207
0.0246
0.0168
0.0220
0.0220
0.0363

0.0246
0.0292
0.0200
0.0262
0.0262
0.0431

0.0168
0.0200
0.0137
0.0179
0.0179
0.0295

0.0220
0.0262
0.0179
0.0234
0.0234
0.0386

0.0220
0.0262
0.0179
0.0234
0.0234
0.0386

0.0363
0.0431
0.0295
0.0386
0.0386
0.0635

difference between two matrices

La-Z-Boy Kimball
La-Z-Boy
Kimball
Flexsteel
Leggett
Miller
Shaw

0.0945
0.0152
0.1624
0.0271
0.0348
0.0626

0.0152
0.0356
0.0247
-0.0199
0.0087
-0.0162

Flexsteel Leggett

0.1624
0.0247
0.3197
0.0596
0.0707
0.1193

0.0271
-0.0199
0.0596
0.0799
-0.0043
0.0212

Miller

0.0348
0.0087
0.0707
-0.0043
0.0360
-0.0142

Shaw

0.0626
-0.0162
0.1193
0.0212
-0.0142
0.1018

14. DATA FOR 6 FURNITURE COMPANIES. In Chapter 8 you were asked to calculate the variancecovariance matrix of returns for six furniture companies. The calculated variance-covariance matrix and mean
returns for these firms are as follows:(see rows 4-10) a. Given this matrix, and assuming that the risk-free rate is 0
percent, calculate the efficient portfolio of these six firms. b. Repeat, assuming that the risk-free rate is 10 percent.
c. Use these two portfolios to generate an efficient frontier for the six furniture companies. Plot this frontier. d. Is
there an efficient portfolio with only positive proportions of all the assets?[

Variance-covariance matrix
La-Z-Boy
Kimball Flexsteel
La-Z-Boy
0.1152
0.0398
0.1792
Kimball
0.0398
0.0649
0.0447
Flexsteel
0.1792
0.0447
0.3334
Leggett
0.0492
0.0062
0.0775
Miller
0.0568
0.0349
0.0886
Shaw
0.0989
0.0269
0.1487

3.1708
0.4861
-2.4405
1.3533
0.0614
1.7712

c = 0%

mean
variance
covariance

Shaw

Means

0.0568
0.0349
0.0886
0.0191
0.0594
0.0243

0.0989
0.0269
0.1487
0.0597
0.0243
0.1653

29.24%
20.68%
25.02%
31.64%
15.34%
43.87%

15.79%

-41.86%

28.09%

25.12%

11.04%

-55.44%

30.74%

1.40%

0.7203
0.1104
-0.5544
0.3074
0.0140
0.4023
1.0000
c = 10%

42.02%
15.79%
-41.86%
28.09%
25.12%
30.85%

72.03%
11.04%
-55.44%
30.74%
1.40%
40.23%

31.35%
4.10%
0.0485016

37.07%
6.15%

0.3

Miller

normalized
weights

sample portfolio calculation

proportion

0.0492
0.0062
0.0775
0.1033
0.0191
0.0597

10%

constant
raw
portfolio

Leggett

transposes
c = 0%

42.02%
c = 10%

72.03%

35.35%
5.42%

1
0.1

1
1.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
1.9
2
2.1
2.2
2.3
2.4
2.5
2.6

sigma
mean
23.28%
35.35%
20.25%
31.35%
19.90%
30.78%
19.56%
30.21%
19.24%
29.64%
18.95%
29.07%
18.69%
28.49%
18.45%
27.92%
18.23%
27.35%
18.05%
26.78%
17.89%
26.21%
17.77%
25.64%
17.67%
25.07%
17.61%
24.49%
17.57%
23.92%
17.57%
23.35%
17.60%
22.78%
17.66%
22.21%

Efficient Frontier
32.0%
30.0%
28.0%
mean

mean
variance

26.0%
24.0%
22.0%
20.0%
17.0% 17.5% 18.0% 18.5%

A crude test to see if we can generate positive portfolio weights we vary r to

see what the portfolio proportions are (in a data table). No portfolio
proportions seem to give a positive weight to the third asset.
Portfolio weights
La-Z-Boy Kimball

-10%
-9%
-8%
-7%
-6%
-5%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%

0.7203
0.298805
0.307591
0.316934
0.326887
0.337513
0.348882
0.361076
0.374187
0.388322
0.403608
0.42019
0.43824
0.457962
0.4796
0.503448

0.1104
0.177103
0.175712
0.174234
0.172659
0.170978
0.169179
0.16725
0.165175
0.162939
0.16052
0.157896
0.15504
0.15192
0.148496
0.144723

Flexsteel

-0.5544
-0.36367144
-0.36764699
-0.37187426
-0.37637795
-0.38118608
-0.38633059
-0.39184807
-0.39778061
-0.40417687
-0.41109342
-0.41859646
-0.42676387
-0.43568798
-0.44547907
-0.45626992

& Platt

0.3074
0.27012646
0.27090391
0.27173058
0.27261132
0.27355158
0.27455763
0.27563662
0.27679677
0.27804761
0.27940019
0.28086747
0.28246467
0.28420985
0.28612457
0.2882348

Miller

0.0140
0.347149
0.340203
0.332817
0.324948
0.316547
0.307558
0.297918
0.287553
0.276377
0.264292
0.251183
0.236913
0.221321
0.204214
0.18536

Shaw

0.4023
0.270488
0.273237
0.276159
0.279273
0.282597
0.286153
0.289968
0.294069
0.298491
0.303273
0.30846
0.314106
0.320276
0.327045
0.334505

5% 0.529862 0.140543 -0.46822191 0.29057211 0.164477 0.342768

6% 0.55928 0.135888 -0.48153309 0.29317521 0.14122 0.35197
7% 0.592245 0.130672 -0.49644931 0.29609219 0.115158 0.362282
8% 0.629439 0.124787 -0.51327949 0.29938346 0.085752 0.373917

the variancematrix and mean

the risk-free rate is 0
ee rate is 10 percent.
ot this frontier. d. Is

means
minus
constant

19.24%
10.68%
15.02%
21.64%
5.34%
33.87%

30.85%
40.23%

Efficient Frontier

18.5% 19.0% 19.5% 20.0% 20.5%

sigma

Number of non-negative
proportions

5 <-- =COUNTIF(D67:I67,">=0")
5
5
5
5
5
5
5
5
5
5
5
5
5
5

5
5
5
5

15. A sufficient condition to produce positively weighted efficient portfolios is

that the variance-covariance matrix be diagonal, that is, that ij = 0, for ij. By
continuity, positively weighted portfolios will result if the offdiagonal elements
of the variance-covariance matrix are sufficiently small compared to the
diagonal. Consider a transformation of this matrix in which
When = 1, this transformation will give the original variance-covariance
matrix, and when = 0, the
transformation will give a fully diagonal matrix.
For r = 10 percent find the maximum for which all portfolio weights are
epsilon

1 <-- Use solver to find epsilon such that minimum portfolio weight = 0.

Variance-covariance matrix
La-Z-Boy Kimball Flexsteel
La-Z-Boy
0.1152
0.0398
0.1792
Kimball
0.0398
0.0649
0.0447
Flexsteel
0.1792
0.0447
0.3334
& Platt
0.0492
0.0062
0.0775
Miller
0.0568
0.0349
0.0886
Shaw
0.0989
0.0269
0.1487
constant

& Platt

0.0492
0.0062
0.0775
0.1033
0.0191
0.0597

Miller

0.0568
0.0349
0.0886
0.0191
0.0594
0.0243

Shaw

0.0989
0.0269
0.1487
0.0597
0.0243
0.1653

La-Z-Boy
Kimball
Flexsteel
& Platt
Miller
Shaw

10%
Explanation

raw
portfolio

3.1708
0.4861
-2.4405
1.3533
0.0614
1.7712

When epsilon = 1, the variance-covariance matrix is the origi

matrix (as in Exercise 1). For this case the optimized portfoli
contains at least one short-selling position (illustrated here).

normalized
weights

0.7203
0.1104
-0.5544
0.3074
0.0140
0.4023

minimum
port. weight
-0.5544

We use Solver to determine epsilon so that the entry in cell E

is zero. You can determine manually that when epsilon is lar
than this, there are short-selling positions.

Epsilon "shrinks" the variance-covariance matrix towards the

diagonal. (Try setting epsilon = 0 to see what this means.)

Here are the Solver settings:

Means

minus
constant

29.24%
20.68%
25.02%
31.64%
15.34%
43.87%

19.24%
10.68%
15.02%
21.64%
5.34%
33.87%

n = 1, the variance-covariance matrix is the original

Exercise 1). For this case the optimized portfolio
ast one short-selling position (illustrated here).

er to determine epsilon so that the entry in cell E22

can determine manually that when epsilon is larger

re are short-selling positions.

nks" the variance-covariance matrix towards the

y setting epsilon = 0 to see what this means.)

A FOUR-ASSET PORTFOLIO PROBLEM

16. This problem returns to the four-asset problem considered in section 7.5:
Calculate the envelope set for these four assets and show that the individual assets all lie
within this envelope set. You should get a graph that looks something like the
following:(see part in right of the calculations)
Mean returns St. dev.
6%
31.62%
8%
54.77%
10%
63.25%
15%
70.71%

Variance-covariance

0.10
0.01
0.03
0.05

0.01
0.30
0.06
-0.04

Constant

0.03
0.06
0.40
0.02

0.05
-0.04
0.02
0.50

0.05

Portfolio 1

Both these portfolios are efficient

Portfolio 2

z
0.3861
0.2567
0.1688
0.2752
Mean
Variance
Covariance

Proportion of 1
Portfolio mean
Portfolio var.
Portfolio st. dev.

x
35.53%
23.62%
15.53%
25.32%

z
-0.0460
0.1091
0.1016
0.2093

0.09372
0.08624
0.11692

0.12707
0.20608

-0.9
15.71%
41.39%
64.34%

y
-12.31%
29.18%
27.17%
55.96%

0.069854 0.743945 -0.39986641

0.413933

Data table of portfolios

-1.4

-1.15
-0.9
-0.65
-0.4
-0.15
0.1
0.35
0.6
0.85
1.1
1.35

0.6434
75.52%
69.89%
64.34%
58.88%
53.55%
48.39%
43.45%
38.84%
34.66%
31.11%
28.41%
26.82%

15.71%
17.37%
16.54%
15.71%
14.87%
14.04%
13.21%
12.37%
11.54%
10.71%
9.87%
9.04%
8.21%

Efficient Frontier Showing the Individual Stocks

20%

18%
Expected portfolio return

Proportion of 1

16%
14%
12%

26.55%
27.63%
29.92%
33.16%
37.12%
41.58%
31.62%
54.77%
63.25%
70.71%

Expected portfolio return

1.6
1.85
2.1
2.35
2.6
2.85
Stock A
Stock B
Stock C
Stock D

7.37%
6.54%
5.70%
4.87%
4.04%
3.20%

12%
10%
8%
6%

Stock A

4%

6.00%
8.00%
10.00%
15.00%

2%

0%
20%

30%

40%
Standard deviation of portfolio

Mean minus
constant
1%
3%
5%
10%

ent Frontier Showing the Individual Stocks

Stock D

Stock C

Stock B

50%

60%

Standard deviation of portfolio

70%

80%

17. The following table shows the var-covar matrix and the mean return for six stocks: a) compute the global minmum
variance portfolio(GMVP), b) compute the efficient portfolio aasuming a monthly trisk-free rate of 0.45%, c) show the
frontier as the expected return and standard deviation.

KR
F
TGT
JNPR
AHO
KEY

Kroger
KR

Ford
F

Target
TGT

Juniper
Networks
JNPR

Ahold
AHO

KeyCorp
KEY

0.0052
0.0033
0.0015
0.0039
0.0068
0.0010

0.0033
0.0120
0.0034
0.0072
0.0063
0.0015

0.0015
0.0034
0.0046
0.0058
0.0039
0.0015

0.0039
0.0072
0.0058
0.0379
0.0073
0.0023

0.0068
0.0063
0.0039
0.0073
0.0389
0.0023

0.0010
0.0015
0.0015
0.0023
0.0023
0.0018

Global mean variance portfolio

KR
F
TGT
JNPR
AHO
KEY
Sum
Mean
Variance
Sigma

(GMVP)

0.0999 <-- {=TRANSPOSE(MMULT(TRANSPOSE(K3:K8),B3:G8)/MMULT(MMULT(TRANSP

0.1554
0.0952
0.2983
Note that the book formula for the GMVP is f
0.3031
vector; here we want a column vector, hence
0.0481
Transpose.
1 <-- =SUM(B11:B16)
-0.33% <-- =SUMPRODUCT(B11:B16,I3:I8)
1.15% <-- {=MMULT(MMULT(TRANSPOSE(B11:B16),B3:G8),B11:B16)}
10.73% <-- =SQRT(B20)

Efficient portfolio

Risk-free

0.45%
KR
F
TGT
JNPR
AHO
KEY
Sum

Mean
Variance
Sigma

0.1067 <-- {=MMULT(MINVERSE(B3:G8),I3:I8-B25)/SUM(MMULT(MINVERSE(B3:G8),I3:

-0.4642
-0.0641
0.0252
-0.1830
1.5794
1 <-- =SUM(B27:B32)
2.33% <-- =SUMPRODUCT(B27:B32,I3:I8)
0.56% <-- {=MMULT(MMULT(TRANSPOSE(B27:B32),B3:G8),B27:B32)}
7.50% <-- =SQRT(B36)

Drawing the efficient frontier: By Proposition 2 of Chapter 9, the efficient frontier is the convex combination of any
two frontier portfolios. Thus combining the GMVP and the efficient portfolio will give us the whole frontier. We do
this below.

Covar

-0.00233966 <-- {=MMULT(MMULT(TRANSPOSE(B11:B16),B3:G8),B27:B32)}, covariance betw

Proportion of GMVP
Proportion of efficient

0.3
0.7 <-- =1-B44

Expected portfolio
return
Portfolio sigma

1.53% <-- =B44*B19+B45*B35

5.30% <-- =SQRT(B44^2*B20+B45^2*B36+2*B44*B45*B42)

Data table: varying proportion of GMVP

-1
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2

5.30%
20.83%
17.99%
15.18%
12.45%
9.85%
7.50%
5.76%
5.24%
6.26%
8.28%
10.73%
13.39%
16.15%
18.97%
21.83%
24.71%

Mean
1.53% <-- =B47, data table header
4.99%
4.46%
5%
3.92%
3.39%
4%
2.86%
2.33%
1.80%
3%
1.27%
0.73%
2%
0.20%
-0.33%
1%
-0.86%
-1.39%
-1.93%
0%
-2.46%
0%
-2.99%
Expected return

Sigma

-1%

-2%

-3%

5%

a) compute the global minmum

free rate of 0.45%, c) show the

Mean
returns
0.24%
-0.89%
0.48%
0.44%
-1.46%
1.04%

1
1
1
1
1
1

8),B3:G8)/MMULT(MMULT(TRANSPOSE(K3:K8),B3:G8),K3:K8))}

the book formula for the GMVP is for a row

re we want a column vector, hence

e.

),B3:G8),B11:B16)}

SUM(MMULT(MINVERSE(B3:G8),I3:I8-B25))}

),B3:G8),B27:B32)}

combination of GMVP and the eficient portfolio.

he convex combination of any

e us the whole frontier. We do

),B3:G8),B27:B32)}, covariance between GMVP & efficient portfolio

Portfolio Returns & Sigma

10%

15%

Standard deviation

20%

25%

Solving an Unconstrained Portfolio Problem

18.To set the scene, consider the following optimization problem, which is solved
without any short-sale constraints. The spreadsheet shows a four asset variancecovariance matrix and associated expected returns. Given a constants c = 8 percent,
find the optimal portfolio . By changing the value of c in the spreadsheet,to c = 3%,
compute other portfolio; show the frontier as the expected return and standard
deviation.

PORTFOLIO OPTIMIZATION ALLOWING SHORT SALES

Variance-covariance matrix

0.10
0.03
-0.08
0.05

0.03
0.20
0.02
0.03

8.0%

3.00%

-0.08
0.02
0.30
0.20

Means

0.05
0.03
0.20
0.90

8%
9%
10%
11%

Optimal portfolio without short sale restrictions (Chapter 9, Proposition 1)

x1
x2
x3
x4
Total

0.2004
0.2587
0.4219
0.1190
1

0.6219 <-- {=MMULT(MINVERSE(B5:E8),G5:G8-C10)/SUM(MMULT(MINVERSE(B

0.0804
0.3542
-0.0565
1

Portfolio mean
Portfolio sigma

9.46%
31.91%

8.62% <-- {=MMULT(TRANSPOSE(C13:C16),$G$5:$G$8)}

19.39% <-- {=SQRT(MMULT(TRANSPOSE(C13:C16),MMULT($B$5:$E$8,C13:C16)

Covariance between
portfolios

4.32% <-- {=MMULT(MMULT(TRANSPOSE(B13:B16),B5:E8),C13:C16)}

Proportion of first

-1
-0.9
-0.8
-0.7
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0
0.1

Sigma
28.17%
26.53%
25.00%
23.60%
22.34%
21.26%
20.39%
19.74%
19.35%
19.23%
19.39%
19.81%

Mean

7.78%
7.86%
7.95%
8.03%
8.12%
8.20%
8.28%
8.37%
8.45%
8.54%
8.62%
8.70%

Portfolio with C=8%

Portfolio with C=3%

20.48%
21.38%
22.48%
23.76%
25.18%
26.72%
28.37%
30.10%
31.91%
33.77%
35.69%
37.65%
39.65%
41.67%
43.73%
45.81%
47.91%
50.02%
52.15%
54.30%
56.46%
58.63%
60.81%
63.00%
65.19%
67.39%
69.60%
71.82%
74.04%
76.27%
78.49%
80.73%
82.97%
85.21%
87.45%
89.70%
91.95%

31.91%
19.39%

8.79%
8.87%
8.96%
9.04%
9.12%
9.21%
9.29%
9.38%
9.46%
9.54%
9.63%
9.71%
9.80%
9.88%
9.96%
10.05%
10.13%
10.22%
10.30%
10.38%
10.47%
10.55%
10.64%
10.72%
10.80%
10.89%
10.97%
11.06%
11.14%
11.22%
11.31%
11.39%
11.48%
11.56%
11.64%
11.73%
11.81%
9.46%
8.62%

C=3% portfolio
13%

Portfolio Returns & Sig

12%

Expected return

0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
1.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
1.9
2
2.1
2.2
2.3
2.4
2.5
2.6
2.7
2.8
2.9
3
3.1
3.2
3.3
3.4
3.5
3.6
3.7
3.8

11%

10%
C=8% portfolio
9%
C=3% portfolio
8%

7%
10%

20%

30%

40%

50%

Standard deviation

/SUM(MMULT(MINVERSE(B5:E8),G5:G8-C10))}

MMULT($B$5:$E$8,C13:C16)))}

Portfolio Returns & Sigma

50%

60%

Standard deviation

70%

80%

90%

100%