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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 Spring '11
 NA
 gross domestic product, 0%, Modern portfolio theory, Meir Statman, oilmarkets

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