BFC2340 Study Guide - Final Guide: Tracking Error, Idiosyncrasy, Risk Measure
8 Aug 2018
School
Department
Course
Professor
Document Summary
Brief review of portfolio theory and risk decomposition: Portfolio mean (or expected return): a weighted average. E(rp)=expected returns of the portfolio, e(r1)=expected return of asset 1, w1=weight (allocation) of asset 1 at the beginning of the period. Portfolio variance: (allocation) of asset 1 at the beginning of the period, cov(r1,r2)=the covariance b/w asset 1 and 2. Sd(r1)=standard deviation of the return of asset 1. Sub the covariance formula into the variance formula: A correlation of 0 means the returns are uncorrelated. Maximum portfolio variance occurs when the correlation is +1. Minimum portfolio variance occurs when the correlation is -1. Application of portfolio theory to bond portfolio construction: The mean-variance framework has been applied to portfolio construction in two ways: at the asset class level, to select securities to construct portfolios. If there are n securities that can be included in a portfolio, there are n variances and (cid:4666)n2 n(cid:4667)/2 covariances. Limitations of using portfolio variance as a risk measure:
