FIN401-Chapter 6 (exam 2)

Negatively calculating portfolio risk calculating

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Unformatted text preview: tfolio Risk Calculating Three factors » Variance (risk) of each security » Covariance between each pair of securities » Portfolio weights for each security Goal: select weights to determine the minimum variance combination for a given level of expected return level Calculating Portfolio Risk Calculating The smaller the positive correlation between smaller securities, the better the As the number of securities increases: » The importance of covariance relationships increases increases » The importance of each individual security’s risk decreases decreases In general, for an n-security portfolio: rp = Weighted average return of the n securities σp2 = (Consider all pair-wise covariance measures) Calculating Portfolio Risk Calculating The risk of a two-security portfolio is The measured as: measured [ σ p = w σ + w σ + 2( w1 )( w2 )( ρ 1, 2 )σ 1σ 2 2 1 2 1 2 2 2 2 1/ 2 Example Problem Example Returns: Bond = 6% Stock = 10% Bond 6% Stock 10% Standard deviation: Bond = 12% Stock = 25% Stock Weights: Bond = 50% Stock = 50% Stock Correlatio...
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