The Alex Sharpe case allows students to gain hands-on experience with the ideas of risk and return and how they interact when assets are combined into a portfolio. You will be asked to quantify the risks associated with individual stocks and portfolios as the concept of relevant risk is demonstrated.
- Estimate and compare the returns and variability (i.e. annual standard deviation over the past five years) of Reynolds and Hasbro with that of the S&P 500 Index. Which stock appears to be riskiest?
- Suppose Sharpe’s position had been 99 percent of equity funds invested in the S&P 500 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? How does this relate to your answer in question 1 above?
- Perform a regression of each stock’s monthly returns on the Index returns to compute a “beta” for each stock. How does this relate to your answer in question 2 above? (It is fine to find a trendline if you are not familiar with regression. See attached note for clarification.
- How might the expected return of each stock relate to its riskiness?
- In what stock(s) (if any) should Sharpe invest?
Sample Solution