Problem1 (20 points). The following are the monthly rates of return for Madison Cookies and for Spphine Electric during a six-month period:

Month

Madison Cookies

(MS inshort)

Sophie Electric

(SE in Short)

1

-0.04

0.07

2

0.06

-0.02

3

-0.07

-0.10

4

0.12

0.15

5

-0.02

-0.06

6

0.05

0.02

Please keep 4 numbers after the decimal point in your answers.

1.a. (4 points) Compute monthly average return for each stock.

1.b. (8 points) Compute standard deviations of returns for each stock

1.c. (6 points) Compute covariance between the returns of the two stock

1.d. (2 points) Compute correlation coefficient of the two stocks' returns.

Problem 2 (20 points). A pension fund manager is considering two mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund. The probability distribution of the risky funds is as follows:

Expected Return

Standard Deviation

Stock fund (S)

0.20

0.30

Bond fund (B)

0.12

0.15

The correlation between the fund returns is 0.10.

Please keep 4 numbers after the decimal point in your answers.

2.a. (2 points) What is the covariance between the two funds' returns?

2.b. (6 points) What are the weights of the two risky funds in the minimum-variance portfolio.

2.c (4 points) What is the expected return of the minimum variance portfolio?

2.d, (8 points) What is the standard deviation of the minimum variance portfolio?

Problem 3 (10 points) As an equity analyst, you have developed the following return forecasts and risk estimates for two different stock mutual funds (Fund T and Fund U):

Forecasted Return

CAPM Beta

Fund T

9.00%

1.20

Fund U

10.00%

0.80

3.a. (6 points) If the risk-free rate (RFR) is 3.9% and the expected market risk premium (i.e., E(R_M) - RFR) is 6.1%, calculate the expected return for each mutual fund according to the CAPM.

3.b. (4 points) Decide which fund is overvalued, undervalued or properly valued and explain why?