Week 3.pptx

# Week 3.pptx - Finance 1 Risk return and diversification...

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Finance 1 Risk, return and diversification

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Value of \$100 invested in 1925 How would you pick a portfolio?
Return on investment Return = Future value per £1 invested Risky return = with probability , for i=1,…,N Average return (mean)

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Mean in probability distribution
Mean in data

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Risk How much does differ from on average? Variance and std.deviation Why squares? Count positive and negative deviations
Variance in probability distribution

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Variance in data
Historical risk and return

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Mean-variance preferences What is utility of risk-averse investor facing a risky return ? Expected utility formulation Tractable approximation: Mean-variance utility Parameter captures risk-aversion (not given in formula sheet) and higher is more risk neutral
Indifference curves

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Investment choice
Activity Download data from my.wbs Use Excel to calculate historical mean return and variance for HSBC and BP Suppose I have mean-variance utility: I can only invest in one of these two stocks For which values of should I invest in BP? For which values should I invest in HSBC?

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