**Portfolio management exercise – Let’s Allocate Across Investments**

**TOTAL POINTS 6**

1.

Question 1

**You would like to estimate the average return of each index in excess of the risk-free rate, that is to say the out-performance. The first step is to compute the excess return for each index for each month. Which of the following formulas gives you the correct answer?**

1 point

0.79% “=C5-D5” in cell E5

-0.36% “=F6-B5” in cell F5

-2.18% “=C5-B5” in cell E5

-2.08% “=C5-average(B5:B292)” in cell E5

2.

Question 2

**Let’s say you consider using an equally weighted portfolio consisting of each index. But first, you would like to examine how this allocation strategy would have done over time. Compute the portfolio returns of an equally weighted portfolio that allocates a weight of 50% to each index at the beginning of each month. Which of the following formulas gives you the correct answer?**

1 point

-2.25% “=0.5*C5+0.5*D5” for the portfolio return in January 1992

-2.57% “=0.5*E5+0.5*F5” for the portfolio return in January 1992

-0.96% “=B292+0.5*C292+0.5*D292” for the portfolio return in December 2015

3.

Question 3

Compute the correlation between the returns of the stock index and the returns of the bond index over the period 1992 to 2015. Which of the following formulas gives you the right answer?

1 point

“=covar(C5:C292,D5:D292)”

“=correl(C5:C292,C5:C292)”

“=correl(C5:C292,D5:D292)”

“=var(C5:C292)*var(D5:D292)”

4.

Question 4

**Based on the correlation that you computed, which of the following is true?**

1 point

The correlation coefficient is negative, meaning that when stocks go down the bond index tends to go down.

The correlation coefficient is positive, meaning that when stocks go down the bond index tends to go down.

The correlation coefficient is positive, meaning that when stocks go down the bond index tends to go up.

The correlation coefficient is negative, meaning that when stocks go down the bond index tends to go up.

5.

Question 5

**Using returns for the entire period from 1992 to 2015, compute the average excess returns of both indexes and the variances of returns. Which of the following is true?**

1 point

“=stdev(F5:F292)” computes the variance of the bond returns which is 1.84%

“=covar(E5:E292,F5:F292)” computes the variance of the stock and the bond index returns which is -0.01%

“=average(C5:C292)” computes the average excess returns for the stock index which is 0.81%

“=var(C5:C292)” computes the variance of the stock index returns which is 0.172%

6.

Question 6

**Assume the covariance between the stock index and the bond index returns is zero. Based on the average excess returns and the variances of returns previously computed, which of the following formulas computes the optimal portfolio allocation to the stock index based on the preference metric used in Module 2, given that your client’s risk aversion is 10?**

1 point

“=J5*I5/(10*K5*L5)”

“=J5*I5/(10*sqrt(K5)*sqrt(L5))”

“=L5*I5/(K5*L5)”

“=L5*I5/(10*K5*L5)”