Leon has in his investment a portfolio that paid him the rate of returns of 14 %, -13%, 15.6%, 17% and 19.5% over the past five years. Required:
- Calculate the arithmetic average return (AAR) and geometric average return (GAR) of the portfolio? If someone asks you what is the actual compounding rate of return of Leon’s portfolio over the past five year, which one (AAR or GAR) will be a better answer?
- Following is forecast for economic situation and Leon’s portfolio returns next year, calculate the expected return, variance and standard deviation of the portfolio.
| State of economy | Probability | Rate of returns |
| Mild Recession | 0.25 | -2.5% |
| Normal | 0.45 | 13.5% |
| Growth | 0.30 | 20% |
c) Assume that expected return of the stock A in Leon’s portfolio is 13.2%. Beta of this stock is 1.2, risk free rate is 3.5%. Calculate market portfolio rate of return, which is used to compute the expected return of this stock by Capital Asset Pricing Model (CAPM)?
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