Chap007 - Investments Bodie, Kane and Marcus CHAPTER 7...

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Unformatted text preview: Investments Bodie, Kane and Marcus CHAPTER 7 CHAPTER 7 Optimal Risky Optimal Risky Portfolios Portfolios 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 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 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 = + + 2 D 2 E ( , ) D E Cov r r w E 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 = + + 7-9 D,E = Correlation coefficient of returns Cov(r D, r E ) = DE D E D = Standard deviation of returns for Security D E = Standard deviation of returns for Security E Covariance 7-10...
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This note was uploaded on 04/19/2011 for the course FINA 513 taught by Professor Chan during the Spring '11 term at Atlantic PR.

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Chap007 - Investments Bodie, Kane and Marcus CHAPTER 7...

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