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Lecture

# Topic 10 lecture 2.doc

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University of Otago

Business Studies

BSNS108

Helen Lu

Spring

Description

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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