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You are an experienced investor in the securities market and you have established an investment portfolio of two blue chips five years ago: Diamond shares with current market value of $235,000 and Platinum shares with current market value of $355,000
You are an experienced investor in the securities market and you have established an investment portfolio of two blue chips five years ago: Diamond shares with current market value of $235,000 and Platinum shares with current market value of $355,000.
Required:
a) If your portfolio has provided you with returns of 10.5%, 12.6%, - 11.5%, 14.5% and 15.2% over the past five years, respectively. Calculate geometric average return of the portfolio for this period.
b) Assume that beta of the Diamond shares in your portfolio is 1.5. The market portfolio expected return is 13.5%, the risk-free rate of return is 7.2%. Calculate expected return of this stock using Capital Asset Pricing Model (CAPM)
c) Assume that you bought 2000 of Platinum shares in your portfolio for a price of $95 each, the dividend paid for this stock is $3/stock each year. Calculate the total return of this investment after five years
Expert Solution
a) Computation of Geometric Average Return:
Geometric Average Return = [(1+r??????1???)(1+r??????2)...(1+r?????????n)]^(1/n)
= [(1 + 0.105) * (1 + 0.126) * (1 - 0.115) * (1 + 0.145) * (1 + 0.152)]^(1/5) - 1
= 1.07751 - 1
Geometric Average Return = 0.0775 or 7.75%
b) Computation of Expected Return of this stock using Capital Asset Pricing Model (CAPM):
Expected Return = Risk Free Rate + Beta * (Market Return - Risk Free Rate)
= 7.2% + 1.5 * (13.5% - 7.2%)
= 7.2% + 9.45%
Expected Return = 16.65%
c) Computation of Total Return on the Investment after 5 Years:
Total Return = (Current Price + Annual Dividend * Years - Purchase Price) / Purchase Price
= (177.5 + 3 * 5 - 95) / 95
Total Return = 1.0263 or 102.63%
Workings:
Annual Dividend = $3 per share
Purchase Price = $95
Current Price = Current Value / Shares = 355,000 / 2,000 = $177.5
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