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Homework answers / question archive / Based on the management team expectations in the previous phase; they have decided to reduce their exposure to credit risk
Based on the management team expectations in the previous phase; they have decided to reduce their exposure to credit risk. But first, they need to know the current exposure to that risk. It is your team resposibility to calculate that. BC Loans AB Expected return 02 5.809% 3.60% CD 4.50% 5.70% 2.90% 3.40% BC CD AB 20.00% Weight Portfolio I Portfolio III Portfolio III 80.00% 70.00% 30.00% 60.00% 40.00% AB CD BC -0.1 Correlation AB BC CD 1 0.21 0.4 1 Expected return VARIANCE Portifolio I Portfolio III Portfolio III
Expected Return on Portfolio, E(RP) = wAB E(RAB) + wBC E(RBC) + wCD E(RCD)
For Portfolio I, E(RP1) = (0.2)(5.8%) + 0 + (0.8)(5.7%) = 5.72%
For Portfolio II, E(RP2) = 0 + (0.3)(4.5%) + (0.7)(5.7%) = 5.34%
For Portfolio III, E(RP3) = (0.4)(5.8%) + (0.6)(4.5%) + 0 = 5.02%
Variance of Portfolio, σP2 = wAB2σAB2 + wBC2σBC2 + wAC2σAC2 + 2wABwBCσABσBCσAB,AC + 2wBCwACσBCσACσBC,AC + 2wABwACσABσACσAB,AC
For Portfolio I, σP12 = (0.2)2(3.6%) + 0 + (0.8)2(3.4%) + 0 + 0 + 2(0.2)(0.8)(√3.6)(√3.4)(0.21) = 2.555%
For Portfolio II, σP22 = 0 + (0.3)2(2.9%) + (0.7)2(3.4%) + 0 + 2(0.3)(0.7)(√2.9)(√3.4)(0.4) + 0 = 2.455%
For Portfolio III, σP32 = (0.4)2(3.6%) + (0.6)2(2.9%) + 0 + 2(0.4)(0.6)(√3.6)(√2.9)(- 0.1) + 0 + 0 = 1.465%
