Lecture 34 - Business Finance (ACC501) Lesson 34 Review of...

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177 Business Finance (ACC501) Lesson 34 Review of the Previous Lecture Variability of Returns Expected Return Expected Risk Portfolio Topics under Discussion Portfolio (Cont.) Risk Systematic vs. Unsystematic Diversification Portfolio Suppose we have the following projections on three stocks Returns State of Economy Probability of state (P) Stock A Stock B Stock C Boom 0.40 10% 15% 20% Bust 0.60 8 4 0 What would be the expected return on a portfolio with equal amounts invested in each of the assets? with half investment in A, remainder divided equally between B and C? The expected returns on individual stocks are calculated as E(R A ) = 8.8% E(R B ) = 8.4% E(R C ) = 8.0% If a portfolio has equal investment in each asset, the portfolio weights are all the same, 1/3 each in this case. So portfolio expected return is: E(R P ) = 1/3 x 8.8% + 1/3 x 8.4% + 1/3 x 8.0% = 8.4% In case of Stock A having half the investment (1/2 weight) and remainder divided equally (1/4 each) between B and C, portfolio returns are: E(R P ) = 1/2 x 8.8% + 1/4 x 8.4% + 1/4 x 8.0% = 8.5%
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178 Portfolio returns pattern for the case where A has 50% weights and B and C have 25% each are: Returns State of Economy Probability of state (P) Stock A Stock B Stock C Portfolio Boom 0.40 10% 15% 20% 13.75% Bust 0.60 8 4 0 5.00 Portfolio returns when economy booms is calculated as: .50 x 10% + .25 x 15% + .25 x 20% = 13.75%
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This note was uploaded on 08/04/2011 for the course ACCT 501 taught by Professor Na during the Spring '11 term at Virtual University of Pakistan.

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Lecture 34 - Business Finance (ACC501) Lesson 34 Review of...

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