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Chap007

# Chap007 - CHAPTER 7 Optimal Risky Optimal Portfolios...

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Investments Bodie, Kane and Marcus CHAPTER 7 CHAPTER 7 Optimal Risky Optimal Risky Portfolios Portfolios

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7-2 Diversification and Portfolio Risk Market risk Systematic or nondiversifiable Firm-specific risk Diversifiable or nonsystematic
7-3 Figure 7.1 Portfolio Risk as a Function of the Number of Stocks in the Portfolio

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7-4 Figure 7.2 Portfolio Diversification
7-5 Covariance and Correlation Portfolio risk depends on the correlation between the returns of the assets in the portfolio Covariance and the correlation coefficient provide a measure of the way returns two assets vary

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7-6 Two-Security Portfolio: Return Portfolio Return Bond Weight Bond Return Equity Weight Equity Return p D E D E P D D E E r r w r w r w w r r = + = = = = = ( ) ( ) ( ) p D D E E E r w E r w E r = +
7-7 = Variance of Security D = Variance of Security E = Covariance of returns for Security D and Security E Two-Security Portfolio: Risk 2 2 2 2 2 2 ( , ) P D D E E D E D E w w w Cov r r σ σ σ σ = + + 2 D σ 2 E σ ( , ) D E Cov r r w E

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7-8 Two-Security Portfolio: Risk Continued Another way to express variance of the portfolio: 2 ( , ) ( , ) 2 ( , ) P D D D D E E E E D E D E w w Cov r r w w Cov r r w w Cov r r σ = + +
7-9 ρ D,E = Correlation coefficient of returns Cov(r D, r E ) = ρ DE σ D σ E σ D = Standard deviation of returns for Security D σ E = Standard deviation of returns for Security E Covariance

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7-10 Range of values for ρ 1,2 + 1.0 > ρ > -1.0 If
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Chap007 - CHAPTER 7 Optimal Risky Optimal Portfolios...

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