Questions:
Q1. Since 1 August 2005, Adam Smith's investment policy has been to lodge fixed (term) deposits at his local bank. The bank pays interest on the maturity date of the deposit. When a deposit matures, Smith's policy is to relodge the whole sum (principle & interest) immediately for further period. He chooses the term of each deposit according to his assessment of the interest rates available at that time. Smith's decisions to date are as follows:
Date Decision
1 August 2005 8 months deposit @ 9.15% pa
1 April 2006 6 months deposit @ 8.45% pa
1 October 2006 10 months deposit @ 8.16% pa
Calculate, as at 1 August 2007, the effective interest rate Smith has earned since he began this policy. (Assume that all months are of equal length). Briefly explain each step.
Q2 Harry Jones has invested one?third of his funds in Share 1 & two?thirds of his funds in Share 2. His assessment of each investment is as follows:
Item Share 1 Share 2
Expected return (%) 15.0 21.0
Standard deviation (%) 18.0 25.0
Correlation between the returns 0.5
(a) What are the expected return & the standard deviation of return on Harry's portfolio?
(b) Recalculate the expected return & the standard deviation where the correlation between the returns is 0 and 1.0, respectively.
(c) Is Harry better or worse off as a result of investing in two securities rather than in one security?