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Example Lec2

# Example Lec2 - Example on Forming an Optimal Portfolio The...

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Example on Forming an Optimal Portfolio The Case of Two Assets Let’s consider investing in two risky assets and one risk-free asset. The two risky assets are two stocks: IBM and Whole Foods (WF). The risk free asset is the 1-month Treasury bill ( T-bill ). Suppose that it is now the end of December 2006. We want to find the optimal portfolio consisting of IBM and WF to invest in. To do that, we first need some data about the returns on the assets we are interested in. We have data that goes back to January of 2002. Based on that, we compute the following statistics: Sample Period: 2002-2006 IBM WF T-bill Average Return 0.0004 0.0173 0.0019 Standard Deviation of Return 0.0825 0.0840 0.0012 Correlation between IBM and WF 0.2659 Using notation from the lecture notes: 0004 . 0 ) R ( E IBM = 0825 . 0 IBM = σ 0173 . 0 ) R ( E WF = 0840 . 0 WF = σ 2659 . 0 WF , IBM = ρ

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Over the period from 2002 to 2006, WF performed better than IBM . This statement is based on a Sharpe ratio analysis: Sharpe Ratio of IBM = 0185 . 0
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