PORTFOLIO THEORY notes

PORTFOLIO THEORY notes - PORTFOLIO THEORY Taken from Bodie,...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
PORTFOLIO THEORY Taken from Bodie, Kane, and Marcus Risk and Risk Aversion 1. Investors avoid risk 2. There is a utility function that includes risk and reward 3. Risk is measured in the context of a portfolio w 1 = $150,000 (up to) w = $100,000 w 2 = $80,000 (down to) E(w) = .6*150,000 + .4*80,000 = 122,000 σ 2 (w) = .6(150,000 – 122,000) 2 + .4(80,000-122,000) 2 = 1,776,000,000 σ(w) = 34,292.86 (std. dev) Consider Treasury Bills as an alternative addition to the portfolio profit $50,000 (profit) risky asset $100,000 $-20,000 (loss) T Bills $5000 (var = 0) Risk premium $22,000 (expected value of the profit) - $5,000 = $17,000. Utility Function Utility function of the Association of Investment Management and Research U = E(r) - .005A σ 2 A an index of risk aversion .005 so that we can use % rather than decimals Example E(r) = 22%, σ = 34% risk premium 17% A = 3 – moderate risk aversion 22-.005*3*34 2 = 4.66% < 5% Stay with Treasuries
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
higher E(r) utility Q E(r p ) p σ p σ Utility function indifference curves
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 11/23/2009 for the course FIN 5208 taught by Professor Murphy during the Spring '09 term at Temple.

Page1 / 5

PORTFOLIO THEORY notes - PORTFOLIO THEORY Taken from Bodie,...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online