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Problem 7-20

Problem 7-20. Texas lotto winner has decided to invest $50,000 a year in the stock market. Stocks for consideration are a petrochemical firm and a public utility. Risk index is assigned to each of the stocks: Petrochemical = 9 Utility = 4

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Problem 7-20

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  1. Problem 7-20 • Texas lotto winner has decided to invest $50,000 a year in the stock market. • Stocks for consideration are a petrochemical firm and a public utility. • Risk index is assigned to each of the stocks: Petrochemical = 9 Utility = 4 • Maximize the return, but the average risk index should not be higher than 6. • Estimated Returns: Petrochemical = 12% Utility = 6% Kelly Devilbiss - Problem 7-20

  2. Solve for: • How much should be invested for each stock? • What is the average risk for this investment? • What is the estimated return for this investment? Kelly Devilbiss - Problem 7-20

  3. QM for Windows P = Petrochemical / U = Utility Maximize: Estimated % return for each stock Total Investment: 1P + 1U = $50,000 Risk Index: 9P + 4U ≤ $300,000 because the average risk index should not be higher than 6. (9P + 4U)/$50,000 ≤ 6 [$50,000 x 6 = $300,000] Estimated Return: .12P + .06U ≤ $6,000 [$6,000 would be the maximum return possible] Kelly Devilbiss - Problem 7-20

  4. QM for Windows - Solve How much should be invested in each stock? Petrochemical = $20,000 Utility = $30,000 What is the estimated return for this investment? $4,200 Kelly Devilbiss - Problem 7-20

  5. Kelly Devilbiss - Problem 7-20

  6. What is the average risk for this investment? 9P + 4U / $50,000 = average risk 9(20,000) + 4(30,000) / 50,000 = 180,000 + 120,000 / 50,000 = 300,000 / 50,000 = 6 Average risk = 6 Kelly Devilbiss - Problem 7-20

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