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Lecture No. 21
Intro to 2-Stock Portfolio Theory
Risk & Expected Return
Batch 6-1 Oct 12th
Copyright: M. S. H
Copyright: M. S. H
-2
-1
-13.24%
+1
+2
+33.24%
Copyright: M. S. H
Return ( r ) %
Our Example
3
Copyright: M. S. H
Copyright: M. S. H
Total Risk
Portfolio Risk
7
20
40
Number of Investments (Stocks) in the Portfolio
Note: About 100% of the Diversifiable Risk (and 50% of the Total
Risk) can be removed by Diversification across 40 stocks. Just 7
carefully chosen Un-Correlated Stocks might be enough to remove
30% of the Total Risk.Copyright: M. S. H
rP * = r1 x1 + r2 x2 + r3 x3 + + rn xn .
Where there are n different investments (ie. Stocks, Bonds,
Projects,) in your portfolio. r1 represents the expected return
(in % pa) on Investment No. 1 and x1 represents the weight of
Investment No. 1 (fraction of the Rupee value of the total
portfolio that Investment No. 1 represents).
Copyright: M. S. H
Copyright: M. S. H
A 2 +XB2 B 2
+ 2 (XA XB
AB )
Definition of Terms:
XA is Investment As weight in the total value of the Portfolio. A
is Investment As Individual Risk (or standard deviation). AB is
the Correlation Coefficient that measures the correlation in the
returns of the two investments. Last term is a Covariance term.
Copyright: M. S. H
AB )
Copyright: M. S. H
10
Portfolio Return
rP*20%
17%
15%
As Risk INCREASES,
the Investors Required
Return INCREASES
13%
10%
5%
9%
Copyright: M. S. H
Risk 11