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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

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

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

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

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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