lec04-tradeoffMeasures - Fin406 Fall 2009 Smeal College of...

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Fin406 – Fall 2009 Smeal College of Business Penn State University 1/20/2010 ©2009 JingZhi Huang 1 Lecture 4: Risk-Return Tradeoff Measures Fin 406 - Fall 2009 Professor Jingzhi Huang Smeal College of Business Penn State University Copyright © 2009 JZH Motivation Evaluate Performance Trade Security Selection Asset Allocation Define Objectives and Constraints Develop Market Expectations •Return •Risk •Tax •Horizon •Economy •Markets •Risk-Return Model •Benchmark Portfolios •Risk-Return tradeoff •Fixed Income •Equity •Cash •Orders •Leverage •Margin •After-tax Returns •Risk •Risk-Adj. Ret. •Benchmarks 2 In asset allocation, the investor needs to consider all the possible combinations of different asset classes and picks the “best” (or the optimal) combination The optimal portfolio for a given investor should be the one that provides the best risk-return tradeoff This calls for a risk-return tradeoff measure that can be used to rank different portfolios I. Mean-Variance Framework Asset allocation Large Cap Bonds (JPMBI) Cash Investor (risk averse) Small Cap (Russell 2K) Commodities (GSCI) 3 In the MV framework, every asset can be characterized by its expected return and variance No “black swans” To investors, assets (or portfolios) differ only by their exp. ret. (the mean) and variance (the risk) Investors differ only by their degrees of risk aversion (or risk tolerance) (E[r 1 ], 1 )( E [ r 2 ], 2 )( E [r 3 ], 3 )( E [ r 4 ], 4 )( E [ r 5 ], 5 ) Methods of Estimating Inputs
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This note was uploaded on 04/06/2010 for the course FIN 100 taught by Professor Staff during the Fall '08 term at Pennsylvania State University, University Park.

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lec04-tradeoffMeasures - Fin406 Fall 2009 Smeal College of...

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