Question
Identify two stocks and name them as first and second stock. Download into an excel worksheet the historical price data on the two stocks from
Identify two stocks and name them as first and second stock. Download into an excel worksheet the historical price data on the two stocks from January 1, 2015 to July 23, 2018 from www.finance.yahoo.com. Compute daily returns on the two stocks for each trading day. Now, using the CORREL function in MS Excel, compute the correlation between the returns on the two stocks. Also compute the expected return and the standard deviation of returns on each of the two stocks using the AVERAGE and the STDEV function in MS Excel. Annualize the expected returns and the standard deviations of the two stocks by assuming that the number of trading days in the year is 252.
Now suppose Ms. X has 9000 shares in the first stock and Mr. Y has 4500 shares in the second stock. Ms. X and Mr. Y decide to get married, and want to allocate their combined wealth between the two stocks in such a way that the standard deviation of the returns on their portfolio is minimized.
(a): Work out the number of shares in each of the two stocks that the risk minimizing portfolio will contain. Indicate how many shares of each of the two stocks will have to be bought or sold to go from the existing portfolio to the risk minimizing portfolio. Assuming that the shares are bought and sold at the closing price on 7/23/2018 with no transactions costs, show that what you spend on buying one of the two stocks exactly equals the proceeds of the sale of the other stock.
(b): Work out E(V1), the expected value of their portfolio at t=1 (one year from today)
(c): Work out the range within which their t=1 wealth will lie with a probability of 95% assuming that the future wealth is normally distributed
*Assuming that the portfolio return is normally distributed, the lower end of the 95% confidence interval is [E(V1) 2*SD(V1)] and the upper end is [E(V1) + 2*SD(V1)].
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