"quantity"exercise:Variance of portfolio

A is correct. Across two periods, there are four possibilities:

■ uu: End Value: $96.80

■ ud: End Value: $79.20

■ du: End Value: $79.20

■ dd: End Value: $64.80

where u is an up move and d is a down move. The probability of an up move followed by a down move is 0.75 × 0.25 = 0.1875. The probability of a down move followed by an up move is 0.25 × 0.75 also = 0.1875. Both of these sequences result in an end value of $79.20. Therefore, the probability of an end value of $79.20 is (0.1875 + 0.1875) = 37.5%. Alternatively, the following formula could be used:

n = 2 (number of periods)

x = 1 (number of up moves: ud and du)

p = 0.75 (probability of an up move)

B is incorrect because it is the probability of an up move followed by an up move (0.75 × 0.75 = 0.5625).

C is incorrect because it is does not recognize that there are two branches that end in $79.20.

B is correct. Specification of the mean and variance for a portfolio of four stocks requires estimates of the mean returns and variances for each of the four stocks and the pairwise correlations between each of the four stocks.

A is incorrect because skewness measures are not required to estimate the mean and variance of a portfolio.

C is incorrect because kurtosis measures are not required to estimate the mean and variance of a portfolio.