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Topic 10 lecture 2.doc

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University of Otago
Business Studies
Helen Lu

Topic 10- Risk, Return, Portfolios, Diversification and the CAPM Lecture 2 Portfolios A grouping of financial assets such as stocks, bonds and cash equivalents, as well as their mutual, exchange-traded and closed-fund counterparts. Portfolios are held directly by investors and/or managed by financial professionals. Think of an investment portfolio as a pie that is divided into pieces of varying sizes representing a variety of asset classes and/or types of investments to accomplish an appropriate risk-return portfolio allocation. The risk and return of the portfolio are determined by the risk and return of the individual assets in the portfolio The forward-looking risk and return of the portfolio are measured by expected return and standard deviation of returns as they are for individual assets Expected return: E(R )=AProbability 1 x Return 1+ Probability 2 x Return 2 …… 2 2 This equation gives us the variance, so Var(R) = 1 1 − E(R] + P2[ 2 E(R) ] to find the standard deviation we simply have to square root the variance. € Portfolio weights The weight of each asset in the portfolio will determine how that asset contributes to the overall return of the portfolio The weighting of an asset is its value in the portfolio as a proportion of total portfolio value Example to illustrate this Suppose you have a $15,000 portfolio as follows. Then the portfolio weighs as follows: Note: SmartTENZ is an exchange-traded fund that invests in the 10 largest companies on the NZ stock exchange. This diversification and the strength of the shares make it a relatively low risk investment Also note the individual weightings of the investments should always add to one Expected portfolio returns when given the stock returns If the individual stocks have the following expected returns, what is he expected return for the portfolio? Portfolio expected return when given the expected stock returns The expected return to a portfolio of m assets is the weighted average of the expected returns for each of the assets in the portfolio Put simply this formula is: E(RP)= weight 1x expected return 1 + weight 2 x expected return 2 The calculation for this would be: E(RP)= 0.667 x 0.128 + 0.333 x 0.079 € =0.111683 0.111683 x 100= 11.17% € Portfolio: E
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