McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Portfolio risk and return measurement Module 5.2.

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McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Portfolio risk and return measurement Module 5.2

11-1 Portfolio examples  Let us turn now to the risk-return tradeoff of a portfolio that is 50% invested in bonds and 50% invested in stocks.  We can later choose any weights we want across bonds and stocks, just as long as the sum of the weights adds to 1.0

The Return and Risk for Portfolios Note that stocks have a higher expected return than bonds and higher risk.

11-3 Portfolios The rate of return on the portfolio is a weighted average of the returns on the stocks and bonds in the portfolio:

11-4 Portfolios The expected rate of return on the portfolio is a weighted average of the expected returns on the securities in the portfolio.

11-5 Portfolios The variance of the rate of return on the two risky assets portfolio is where  BS is the correlation coefficient between the returns on the stock and bond funds.

11-6 Portfolios Observe the decrease in risk that diversification offers. An equally weighted portfolio (50% in stocks and 50% in bonds) has less risk than either stocks or bonds held in isolation.

11-7 Notes: 2-asset portfolio variance  Note that the variance (or standard deviation) is NOT a simple weighted average of the individual asset’s variances (or standard deviations)  Note that the correlation (or covariance) between the asset returns will be a critical determinant of the portfolio’s risk.