# Project on portfolios and cash flows

\$10,000 is

invested in a single asset that returns 7 percent annually for

twenty-five years and \$2,000 is placed in five different

investments, earning returns of 100 percent, 0 percent, 5 percent,

10 percent, and 12 percent, respectively, over the twenty-year

time frame. For each of the questions below, begin with the

original scenario presented in the table:

a. Experiment with the return on the fifth asset. How low can the

return go and still have the diversified portfolio earn a higher

return than the single-asset portfolio?

b. What happens to the value of the diversified portfolio if the

first two investments are both a total loss?

c. Suppose the single-asset portfolio earns a return of 8 percent

annually. How does the return of the single-asset portfolio

d. Assume that Asset 1 of the diversified portfolio remains a

total loss (–100% return) and asset two earns no return.

Make a table showing how sensitive the portfolio returns are

to a 1-percentage-point change in the return of each of the

other three assets. That is, how is the diversified portfolio’s

value affected if the return on asset three is 4 percent or 6

percent? If the return on asset four is 9 percent or 11

percent? If the return on asset five is 11 percent? 13 percent?

How does the total portfolio value change if each of the three

asset’s returns are one percentage point lower than in the

table? If they are one percentage point higher?

e. Using the sensitivity analysis of (c) and (d), explain how the

two portfolios differ in their sensitivity to different returns on

their assets. What are the implications of this for choosing

between a single asset portfolio and a diversified portfolio?

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