Single assets

∑𝑅
Expected return ER= 𝑛

∑(𝑅−𝐸𝑅)2
Variance 𝜎 2 = 𝑛−1
𝑜𝑟 ∑(𝑅 − 𝐸𝑅)2 𝑝

∑(𝑅−𝐸𝑅)2
Standard deviation 𝜎 = √ 𝑛−1
or √∑(𝑅 − 𝐸𝑅)2 𝑝

𝜎
Coefficient of variation = 𝐸𝑅

Portfolio

ERp =Wa*ERa+Wb*ERa+…..

Variance 𝜎 2 𝑝 = 𝑊𝑎2 ∗ 𝜎𝑎2 + 𝑊𝑏 2 ∗ 𝜎𝑏 2 + 2𝑊𝑎𝑊𝑏 𝐶𝑜𝑣𝑎, 𝑏

𝐶𝑜𝑣𝑎, 𝑏 = 𝜎𝑎 ∗ 𝜎𝑏 ∗ 𝑟𝑎, 𝑏 given r a,b correlation

∑(𝑅𝑎−𝐸𝑅𝑎)(𝑅𝑏−𝐸𝑅𝑏)
𝐶𝑜𝑣𝑎, 𝑏 = or ∑(𝑅𝑎 − 𝐸𝑅𝑎)(𝑅𝑏 − 𝐸𝑅𝑏)𝑝
𝑛−1

𝐶𝑂𝑉𝑎,𝑏
β=
𝜎𝑚2

Required rate of return under capital market line RRR = 𝑅𝐹 + 𝛽𝑝(𝐸𝑅𝑀 − 𝑅𝐹)

𝐸𝑅𝑀−𝑅𝐹
Required rate of return under Security market line = 𝑅𝐹 + 𝜎𝑝 ( )
𝜎𝑚

𝜎𝑏 2 − 𝐶𝑜𝑣(𝑎, 𝑏)
𝑊𝑎 =
𝜎𝑎2 + 𝜎𝑏 2 − 2𝐶𝑜𝑣(𝑎, 𝑏

Example in lecture

PR RA RB RC Rm
0.3 -5% -10% 20% 5%
0.4 10% 10% 10% 10%
0.3 20% 30% -5% 15%

RF= 5%
Solution

Security A

PR Ra Ra -Era (Ra- Rm Rm-ERm (Rm-ERm)^2 (Ra -

Era)^2 Era)(Rm-
rm)*p
0.3000 -0.0500 -0.1350 0.0055 0.0500 -0.0500 0.0008 0.0020
0.4000 0.1000 0.0150 0.0001 0.1000 0.0000 0.0000 0.0000
0.3000 0.2000 0.1150 0.0040 0.1500 0.0500 0.0008 0.0017
ERa=0.085 %

𝜎𝑎2 =0.009525

𝜎𝑎= 0.097596

CV= 1.148189

Covara,m= 0.003750

beta a,m =2.5

RRRa= 5%+2.5(10%-5%)=0.175

Security b

PR Rb Rb -ERb (Rb-ERb)^2 Rm Rm-ERm (Rm-ERm)^2 (Rb -ERb)(Rm-ERm)*p

0.3000 0.3 -0.0400 0.0005 0.0500 -0.0500 0.0008 0.0006
0.4000 0.4 0.0600 0.0014 0.1000 0.0000 0.0000 0.0000
0.3000 0.3 -0.0400 0.0005 0.1500 0.0500 0.0008 -0.0006

ERb= 0.3400

𝜎𝑏 2 =0.0024

𝜎𝑏= 0.04899

CV= 0.144088

Covarb,m= 0

β B,m = 0

RRRb= 5%+0 =0.05

Security C

PR Rc Rc -ERc (Rc- Rm Rm-Erm (Rm- (Rc -Erc)(Rm-

ERc)^2 Erm)^2 Erm)*p
0.3000 20% 0.1150 0.0040 0.0500 -0.0500 0.0008 -0.0017
0.4000 10% 0.0150 0.0001 0.1000 0.0000 0.0000 0.0000
0.3000 -5% -0.1350 0.0055 0.1500 0.0500 0.0008 -0.0020

ERc= 0.0850

𝜎𝑐 2 = 0.009525

𝜎𝑐= 0.097596

CVc= 1.148189

Covarc,m= -0.003750

β c,m = -2.5

RRRc= 5%+-2.5(0.10-5%) =-0.075

Portfolio A,B

PR Ra Ra -Era (Ra-Era)^2 PR Rb Rb -ERb (Rb-ERb)^2 (Ra -Era)(Rb -Erb)

0.3000 -0.0500 -0.1350 0.0055 0.3000 0.3 -0.0400 0.0005 0.0054
0.4000 0.1000 0.0150 0.0001 0.4000 0.4 0.0600 0.0014 0.0009
0.3000 0.2000 0.1150 0.0040 0.3000 0.3 -0.0400 0.0005 -0.0046
Era 0.0850 ERb 0.3400
Variance 0.0095 0.0024
standard deviation 0.097596 0.04899
CV 1.148189 0.144088
Covar 0.001700

Wa= 0.082111437

Wb=1-0.082111437=0.917888563

ER(a,b)= 0.319061584
Variance =0.002278849

Standard deviation= 0.047737293

CV= 0.149618

Beta = 1.133333333

0.1−5%
RRR= 5%+0.047737293*(0.03873)=11%