Tutorial 1A

1) You are planning to save for retirement over the next 30 years. To do this, you will invest $700 a month
in a stock account and $300 a month in a bond account. The return of the stock account is expected to
be 11 percent, and the bond account will pay 6 percent. When you retire, you will combine your money
into an account with a 9 percent return. How much can you withdraw each month from your account
assuming a 25-year withdrawal period?

2) Consider the following information on three stocks:

State of Probability of Rate of Return if State Occurs

Economy State of Stock A Stock B Stock C
Economy
Boom 0.35 0.24 0.36 0.55
Normal 0.50 0.17 0.13 0.09
Bust 0.15 0.00 -0.28 -0.45

a. If your portfolio is invested 40 percent each in A and B and 20 percent in C, what is the portfolio expected
return? The variance? The standard deviation?
b. If the expected T-bill rate is 3.80 percent, what is the expected risk premium on the portfolio?
c. If the expected inflation rate is 3.50 percent, what are the approximate and exact expected real returns on the
portfolio? What are the approximate and exact expected real risk premiums on the portfolio?

3) A stock has a beta of 1.35 and an expected return of 16%. A risk-free asset currently earns 4.8%.

a. What is the expected return on a portfolio that is equally invested in the two assets?
b. If a portfolio of the two assets has a beta of 0.95, what are the portfolio weights?
c. If a portfolio of the two assets has an expected return of 8%, what is its beta?
d. If a portfolio of the two assets has a beta of 2.70, what are the portfolio weights? How do you interpret the
weights for the two assets in this case? Explain.

4) Consider the following information about Stock I and II:

State of Economy Probability of State of Economy Rate of Return

Stock I Stock II
Recession 0.25 0.11 -0.40
Normal 0.50 0.29 0.10
Irrational exuberance 0.25 0.13 0.56

The market risk premium is 8 percent, and the risk-free rate is 4 percent.

Which stock has the most systematic risk?

Which one has the most unsystematic risk?
Which stock is “riskier”?
Explain.