week8 - Covariance between the stock Portfolio Risk E R p =...

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Week 8 Tutorial Emily Lo
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Risk and Return Relationship Return >> the gain/loss of an investment >> Dollar return = Amt received – amt invested >> Rate of return = Dollar return / amt invested Risk >> chance that the payoffs vary from the expected value >> unexpected loss is risk Returns compensate investors for bearing risk >> higher the potential return, higher the risk Risk can be analysed in >> stand alone basis
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Stand alone Risk Standard Deviation >> how far the distribution deviates from its mean (expected return) >> Based on future probabilities and returns >> Based on historical returns σ k = ( k i - E ( R k )) 2 xP i i =1 n E ( R k ) = P i k i i =1 n ( r ~ ) = ( r t - r _ ) 2 t =1 n n - 1 r _ = r t t =1 n n
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Portfolio Risk Weight of each security=Asset value/Total value of Portfolio Expected return on a portfolio
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Unformatted text preview: Covariance between the stock Portfolio Risk E ( R p ) = w i E ( R i ) i =1 n σ ij = r ij s i s j ij = ( r i , t-E ( R i ))( r j , t-E ( R j )) t =1 n n- 1 p = w i w j s ij j =1 n i =1 n Diversification Total Risk has two components >> Diversifiable risk (firm specific/unsystematic)- risk that affects specific firms- can be eliminated through proper diversification >> Non Diversifiable risk (market/systematic risk)- affects all firms in the market- cannot be reduced by diversification Since unsystematic risk can be eliminated through diversification, there is no reward for bearing unsystematic risk >> expected return on a risky asset only depends on asset’s market risk...
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week8 - Covariance between the stock Portfolio Risk E R p =...

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