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Alex Sharpe's Portfolio Solution

In: Business and Management

Submitted By lahuy85
Words 1242
Pages 5
Context:
Alex Sharpe currently invests her children’s educational savings in Vanguard 500 Index Fund, which tracks the performance of S&P 500 and is passively managed. However, she is now considering switching her investment strategy to a more active one to achieve better outcomes. Hasbro, a toy manufacturer, and Reynolds, a tobacco firm, have come into Sharpe’s sight and she wants to choose one of them and invest a small proportion of equity funds in it.
In order to select a more appropriate investment target, the following issues should be taken into consideration by Sharpe: 1) What are the risk-return characteristics of each stock 2) What are the impacts of either stock to the overall risk-return profiles of the equity portfolio

Analysis:
1. Suppose Sharpe's position had been 99 percent of equity funds invested in the S&P500 and either one percent in Reynolds or one percent in Hasbro. Estimate the resulting portfolio position. How does each stock affect the variability of the equity investment? Which stock appears to be the riskiest?
Let A (and B) be the portfolio with 99% of S&P 500 and 1% of Reynolds (and 1% Hasbro). | S&P 500 | Reynolds | Hasbro | Portfolio A | Portfolio B | Mean Return | 0.5743% | 1.8748% | 1.1838% | 0.5873% | 0.5804% | Std Dev | 3.6017% | 9.3665% | 8.1158% | 3.5933% | 3.6174% |
According to our calculation, Portfolio A is a better choice with higher expected return (0.5873%) and lower standard deviation (3.5933%).
It is interesting to notice that although Reynolds has much higher standard deviation than Hasbro when they are considered in isolation, the contribution of Reynolds to Sharpe’s portfolio is less than that of Hasbro. It is due to the much lower correlation of Reynolds’s return and the whole market index in comparison to that of Hasbro. Therefore, if an investor intends to hold a single stock,

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