Explain the term ‘efficient frontier’. Hence or otherwise, identify which one(s) of the portfolios above are inefficient. Carefully justify your choice.

PART A: Return statistics
You should start by calculating the daily returns of the FTSE 100, stock A, and your stock for the whole period.
1. Present the daily returns for just September in a table. [6 marks]
2. For the whole period calculate the arithmetic average daily returns of the FTSE 100, stock A, and your stock. Comment on the ranking of these assets. [6 marks]
3. For the whole period calculate the standard deviations of the FTSE 100, stock A, and your stock. Comment on the riskiness of these assets according to their volatilities. [6 marks]
4. Calculate the correlation between stock A and the FTSE 100, and between your stock and the FTSE 100. Do you have any evidence to show that your stock ‘moves with the market’ more than stock A does? [6 marks]
5. Calculate the betas of stock A and your stock. Interpret these numbers. Do these numbers make sense empirically? [6 marks]
6. In no more than 500 words try to relate the statistics from questions 2-5 to recent developments in financial markets and the global economy. [30 marks]
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ECO-M015 Finance Autumn 2015
[In question 6 we are looking for you to comment on the performances of ‘your stock’, ‘stock A’ and the FTSE 100. Can we explain the financial statistics you have calculated based on events in the global economy, the specific industry the companies operate in, or perhaps something specific to one of the companies?]
PART B: Portfolio analysis
Let us consider a two-share portfolio which comprises stock A and your stock.
6. Write down the expression for the daily return of your portfolio (based on historical data), and its volatility. Describe your notation clearly. [4 marks] Explain why historical data might not be useful for the purposes of investing? Why is historical data still often used? [6 marks]
7. Calculate the return, and standard deviation of the following portfolios.
(i) All stock A
(ii) All your stock
(iii) 25% stock A; 75% your stock (iv) 75% stock A; 25% your stock (v) Equally weighted
Chart the risk/return profile using these portfolios; mark the corresponding number of each portfolio on your chart. [10 marks]
8. Explain the term ‘efficient frontier’. Hence or otherwise, identify which one(s) of the portfolios above are inefficient. Carefully justify your choice. [10 marks]
9. Assume that the daily risk-free rate is negligible. Which of the above portfolios is optimal according to the Sharpe ratio? Explain your answer carefully. [5 marks]
10. Which of the above portfolios would you recommend to an extremely risk-averse investor? Why? [5 marks]