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Unformatted text preview: Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Eighth Edition by Frank K. Reilly & Keith C. Brown Chapter 7 Chapter 7  An Introduction to Portfolio Management Questions to be answered: • What do we mean by risk aversion and what evidence indicates that investors are generally risk averse? • What are the basic assumptions behind the Markowitz portfolio theory? • What is meant by risk and what are some of the alternative measures of risk used in investments? Chapter 7  An Introduction to Portfolio Management • How do you compute the expected rate of return for an individual risky asset or a portfolio of assets? • How do you compute the standard deviation of rates of return for an individual risky asset? • What is meant by the covariance between rates of return and how do you compute covariance? Chapter 7  An Introduction to Portfolio Management • What is the relationship between covariance and correlation? • What is the formula for the standard deviation for a portfolio of risky assets and how does it differ from the standard deviation of an individual risky asset? • Given the formula for the standard deviation of a portfolio, why and how do you diversify a portfolio? Chapter 7  An Introduction to Portfolio Management • What happens to the standard deviation of a portfolio when you change the correlation between the assets in the portfolio? • What is the riskreturn efficient frontier? • Is it reasonable for alternative investors to select different portfolios from the portfolios on the efficient frontier? • What determines which portfolio on the efficient frontier is selected by an individual investor? Background Assumptions • As an investor you want to maximize the returns for a given level of risk. • Your portfolio includes all of your assets and liabilities • The relationship between the returns for assets in the portfolio is important. • A good portfolio is not simply a collection of individually good investments. Risk Aversion Given a choice between two assets with equal rates of return, most investors will select the asset with the lower level of risk. Evidence That Investors are Risk Averse • Many investors purchase insurance for: Life, Automobile, Health, and Disability Income. The purchaser trades known costs for unknown risk of loss • Yield on bonds increases with risk classifications from AAA to AA to A…. Not all Investors are Risk Averse Risk preference may have to do with amount of money involved  risking small amounts, but insuring large losses Definition of Risk 1. Uncertainty of future outcomes or 2. Probability of an adverse outcome Markowitz Portfolio Theory • Quantifies risk • Derives the expected rate of return for a portfolio of assets and an expected risk measure • Shows that the variance of the rate of return is a meaningful measure of portfolio risk • Derives the formula for computing the variance of a portfolio, showing how to effectively diversify a portfolio Assumptions of...
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 Spring '09
 YOST
 Management, Standard Deviation, Variance, Markowitz Portfolio Theory

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