This preview shows page 1. Sign up to view the full content.
Expected return
is the “weighted average” return on a risky asset, from today to some future date
To calculate an
expected return, you must first
: Decide on the number of possible economic scenarios (states) that might occur.
Estimate how well the security will perform in each state, and Assign a probability to each state
Portfolios
are
groups of assets, such as stocks and bonds, that are held by an investor.
Portfolio weights
the proportion of the
total value of the portfolio that is invested into each asset
Correlation
: The tendency of the returns on two assets
to move together. Imperfect correlation is the key reason why diversification reduces portfolio risk as measured by
the portfolio standard deviation.
Imperfect correlation
, positive or negative, is why diversification reduces portfolio
risk.
Investment opportunity set:
The various combinations of risk and return available all fall on a smooth curve. It
shows the possible combinations of risk and return available from portfolios of these two assets
Efficient Portfolio
A portfolio that offers the highest return for its level of risk
Dominated/Inefficient
The undesirable portfolios
The
Markowitz Efficient frontier
is the set of portfolios with the maximum return for a given risk AND the minimum risk
given a return. For the plot, the upper lefthand boundary is the Markowitz efficient frontier.
All the other possible
combinations are inefficient
. That is, investors would not hold these portfolios because they could get either more
This is the end of the preview. Sign up
to
access the rest of the document.
 Fall '08
 phsiao

Click to edit the document details