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Unformatted text preview: Click to edit Master subtitle style Lecture 14-15 Risk and Return Efficient diversification Background for Project 2 Chapters 5.3, 5.5 and 6 Prof Irvine Prof Irvine Volatility Usually, but not always measured as the standard deviation of stock returns Prof Irvine Leptokurtosis Implication?  is an 5-3 Prof Irvine Table 5.3 Prof Irvine Geom. Arith. Excess Series Mean% Mean% Return% Kurt. Skew. World Stk 9.20 11.00 7.25 1.03-0.16 US Lg. Stk 9.34 11.43 7.68-0.10-0.26 Sm. Stk 11.43 17.26 13.51 1.60 0.81 World Bnd 5.56 5.92 2.17 1.10 0.77 LT Bond 5.31 5.60 1.85 0.80 0.51 Prof Irvine Prof Irvine Prof Irvine Prof Irvine Prof Irvine Prof Irvine Volatility over time - VIX Volatility has beenwell, volatile recently increasing to surprisingly high levels not seen since the 1930s. Then quieting down Then exploding once more Prof Irvine Prof Irvine Volatility over time - Updated Prof Irvine This is the VIX more recently 2 years Prof Irvine Prof Irvine Prof Irvine How can an investor protect herself from volatility? Invest part of the assets in a risk-free security! l No such animal l What is the risk free rate? Use a proxy A proxy is? l Talked about during the KO case Prof Irvine Prof Irvine Possible to split investment funds between safe and risky assets Risk free asset: proxy; T-bills Risky asset: stock (or a portfolio) Allocating Capital Between Risky & Risk- Free Assets Prof Irvine Prof Irvine Two-Security Portfolio: Return Rc = w 1 R 1 + w 2 R 2 W 1 = Proportion of funds in Security 1 W 2 = Proportion of funds in Security 2 R 1 = Expected return on Security 1 R 2 = Expected return on Security 2 Prof Irvine Prof Irvine rf = 7% = 0 % E(rp) = 15% = 2 2 % w 1 = % in P (1- w 1 ) = % in rf Example Prof Irvine Prof Irvine E(rc) = w 1 E(rp) + (1 - w 1 )rf rc = complete or combined portfolio For example, w 1 = .75 E(rc) = .75(.15) + .25(.07) = .13 or 13% Expected Returns for Combinations Prof Irvine Prof Irvine Variance on the Possible Complete Portfolios Since we assume that the variance on the risk free asset is = 0. The only risk in the complete portfolio must come from the risky asset....
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lecture14_15 - Click to edit Master subtitle style Lecture...

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