I.

Quantitative Analysis
50% 50% Expected Standard
Scenario Probability High-tech Counter – Returns Return Deviation
(P) (H) cyclical (r) (^r ¿
(B) (H + B) ( r^ ∗P) ¿

Recession 20% -5% 20% 7.50% 1.50% 0.000198

Near 20% 2% 16% 9% 1.80% 0.000054
Recession

Normal 30% 15% 12% 13.50% 4.05% 0.000244

Near boom 10% 25% -9% 8% 0.80% 0.000070

Boom 20% 45% -20% 12.50% 2.50% 0.000068

10.65% =0.000634

√ 0.000634
2.52%
Table 1.1- Expected Return and Standard Deviation Comprises 50% each of High-Tech
Company’s Stocks and Counter- Cyclical Company’s Stock.

High-tech Counter –
cyclical
15.4% 5.9%
Expected return
17.69% 15.69%
Standard deviation
a. Construct investment with Lower risk.
Table 1.2 - Expected Return and Standard Deviation Comprises of High-Tech Company
and Counter- Cyclical Company.

b. To further explain the advantages of diversification and help Mary think critically,

Bill May opted to illustrate 2 different options.

Illustration 1: Finding the expected return and standard deviation of a

portfolio that comprises 50% of high-tech stocks and 50% of counter

cyclical stocks.
 (Refer to Table 1 computation)

Illustration 2: Finding the expected return and standard deviation of a

portfolio that comprises 70% of portfolio in the High-Tech stocks and

30% in the Index Fund.

70% 30% Expected Standard

Scenario Probability High-Tech Index fund Returns Return Deviation

(P) (r) (^r ¿

(H + I) ( r^ ∗P) ¿
Recession 20% -5% -2% -4.10% -0.82% 0.006415362

Near 20% 2% 5% 2.9% 0.58% 0.002380562

Recession
Normal 30% 15% 10% 13.50% 4.05% 0.000002883
Near 10% 25% 15% 22% 2.20% 0.0006707761

boom
Boom 20% 45% 25% 39% 7.80% 0.012690722
13.81% =0.0221603051

√0.0221603051

14.89%
Table 2 Expected Return and Standard Deviation Comprises 70 % stocks of High-Tech

Company and 30% from Index Fund

c. To build an investment portfolio with a combination of 30:30:40 among 3

different companies: Counter Cyclical Co., Utility Company, and High-tech

Company.

30% 30% 40% Expected Standard

Scenario Probability High- Counter- Utility Returns Return Deviation

(P) tech Cyclical company (r) (^r ¿

(H) (C) (U) (H + I) ( r^ ∗P) ¿

Recession 20% -5% 20% 6% 6.9% 1.38% 0.000200978

Near 20% 2% 16% 7% 8.2% 1.64% 0.000069938

Recession
Normal 30% 15% 12% 9% 11.7% 3.51% 0.000079707

Near 10% 25% -9% 11% 9.2% 0.92% 0.000007569

boom
Boom 20% 45% -20% 14% 13.1% 2.62% 0.000183618

10.07% =.00054181

√.00054181

2.33%
Table 3. Combination of 30:30:40 among Counter-Cyclical Co., Utility Company and

High-Tech Company.

II. Qualitative Analysis

Mary as being clueless on the terms used in financial markets. First step that Bill

needs to explain as a financial advisor is the term that being used. The following are the

terms and concepts used in managing and analyzing the investment portfolio:
 1. Risk is the chance of financial loss and used interchangeably with uncertainty

to refer to the variability of return associated with a given asset. Moreover,

Assets having greater chances of loss are viewed as among risky than those

with lesser chances of loss.

2. Returns is commonly measured as cash distributions of total gain or loss

experienced on an investment over a given period of time. To asses risk, we

must know the meaning of return is and how to measure it.

3. Standard Deviation is to indicate the riskiness of an asset that measures the

dispersion around the expected value. When prices move wildly, standard

deviation is high, meaning an investment will be risky while low standard

deviation means prices are calm, so investments come with low risk.

Furthermore, these term and concept were used in quantitative analysis of a qualitative

above computation. Below are the analysis of each alternative course of action.

a. Construct investment with Lower risk.

Diversification reduces the portfolio’s variability and thereby enables

investors to earn a more stable rate of return. Since High-tech Co. and Counter-

cyclical Co. are negatively correlated with each other, Bill demonstrated the

advantages of diversification by calculating the expected return which is the predicted

total gain or loss experienced on an investment over a given period of time and the

risk or the chance of financial loss such as standard deviation that indicates the

riskiness of the assets which measures the dispersion around expected value of these

investments in one portfolio. The data in the Table 1.1 and 1.2 shows that a portfolio

comprised of equal investments in the High-Tech Company and Counter-Cyclical

would provide an expected rate of return that would be in between the returns of the

two stocks with an expected risk level that would be much smaller than either of the

two stocks’ expected standard deviation.

b. Illustration 1: Finding the expected return and standard deviation of a portfolio

that comprises 50% of high-tech stocks and 50% of counter cyclical stocks.

Diversification is the process of allocating capital in a way that reduces the

exposure to any one particular asset or risk. A diversified portfolio includes

different kinds of assets which work because uncorrelated assets react differently

with each other. When investments in one area perform poorly, other investments

in the portfolio can offset losses.

Illustration 2: Finding the expected return and standard deviation of a portfolio

that comprises 70% of portfolio in the high-tech stocks and 30% in the index

fund.

As illustrated in Table 2 , the 70%:30% portfolio that is composed of high-

tech and index fund would not necessarily be better for Mary, since it has much

higher expected level of risk (14.89% versus 2.52%) and only a slightly higher

level of expected return (13.81% versus 10.65%) visa vis the 50%:50% portfolio

of High-tech and the Counter-cyclical. By presenting these portfolios to Mary, she

can now understand how risk is related to returns and learn how to make use of

the information to improve decision making. The first illustration is deemed the

better portfolio.
c. To build an investment portfolio with a combination of 30%:30%:40% among 3

different companies: Counter Cyclical Co., Utility Company, and High-tech

Company.

As Mary has agreed that she doesn’t need the high risk given her status in

life, Billy come-up with this diversified portfolio. Although this portfolio is

already a better option, it still has its weaknesses like low returns compared to the

50%:50% portfolio but this only happens because the risk is also low. The

relationship between risk and return is direct that is why the higher the risk, the

higher the return, and vice versa. This portfolio has a 2.33% of standard deviation

(risk) which is not bad for a 10.07% return.