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FIN 501 (31)
Chapter 2

Chapter 2 Diversification and Asset Allocation.docx

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Ryerson University
FIN 501
Edward Blinder

FIN501 investment analysis I CHAPTER 2 DIVERSIFICATION AND ASSET ALLOCATIONEXPECTED RETURNS AND VARIANCESExpected return average return on a risky asset expected in the futureCan calculate the projected or expected risk premium as the difference between the expected return on a risky investment and the certain risk on a riskfree investment Risk premiumexpected returnriskfree rateCalculating average return and variance is different because we are given the projected future returns and their associated probabilitiesEX Calculating expected risk premium and risk premium Risk free investment is 8ER0520057025 N Risk premium25817PORTFILIOSPortfolio group of assets such as stocks and bonds held by an investorPortfolio weight percentage of a portfolios total value invested in a particular asset ERx X ERx X ERx X ER P1122nn When the return R is the same no matter the state of the economy the portfolio has a zero variance and no risk P EX Calculating expected portfolio return and portfolio variance assuming owning only two stocks 1 2 3 4 State of the economy Probability of return Portfolio return if occurs Product 2X3 Recession 05 052005305 0025 Boom 05 0520053040 0200ER225 P 1 2 3 4 5 State of the economy Probability of return Portfolio Return if Squared
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