Ocf Functions

Gregory Walker

620001881

October 22, 2015

AGEC 431

Ch.8 Mini-Case

Pioneer Gypsum has a covariance of 0.01664. Using the covariance matrix, the best allocation in the S&P 500 and Pioneer is found. Adding Pioneer to the market benchmark in fact improves the Sharpe ratio from 0.4688 to 0.4702. This increase, as shown in Table 1.1, is found using Pioneer for 5%, and the market for 95%. These amounts in each maximize the Sharpe Ratio.

For Global Mining the covariance is equal to 0.03123, which is a higher covariance than Pioneer depicts by almost two points. Global Mining correlates to the market at 0.976, which is a fairly high correlation. Global Mining also has a substantially higher beta, it being 1.22. John’s expected rate of return is too low for the risk associated with Global Mining. Therefore John should not invest in Global Mining and look to better use his funds in Pioneer or another market security. The Sharpe Ratio is maximized without any part of the portfolio in Global Mining. However, if John were to short sell the Sharpe Ratio increases marginally. This is depicted in Table 1.2. John should not invest in Global Mining.

In maximizing the Sharpe Ratio, John should invest in Pioneer Gypsum 5% of his portfolio. However, the same maximization does not occur if he invests in Global Mining, and therefore he should refrain from investing in Global Mining or risk decreasing his Sharpe Ratio.