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Unformatted text preview: CHAPTER 7 – PORTFOLIO THEORY ANSWERS TO ENDOFCHAPTER QUESTIONS 71. Historical returns are realized returns, such as those reported by Ibbotson Associates and Wilson and Jones in Chapter 6 (Table 66). Expected returns are ex ante returnsthey are the most likely returns for the future, although they may not actually be realized because of risk. 72. The expected return for one security is determined from a probability distribution consisting of the likely outcomes, and their associated probabilities, for the security. The expected return for a portfolio is calculated as a weighted average of the individual securities’ expected returns. The weights used are the percentages of total investable funds invested in each security. 73. The Markowitz model is based on the calculations for the expected return and risk of a portfolio. Another name associated with expected return is simply “mean,” and another name associated with the risk of a portfolio is the “variance.” Hence, the model is sometimes referred to as the meanvariance approach. 74. The expected return for a portfolio of 500 securities is calculated exactly as the expected return for a portfolio of 2 securitiesnamely, as a weighted average of the individual security returns. With 500 securities, the weights for each of the securities would be very small. 75. Each security in a portfolio, in terms of dollar amounts invested, is a percentage of the total dollar amount invested in the portfolio. This percentage is a weight, and the general assumption is that these weights sum to 1.0, accounting for all of the portfolio funds. 76. The expected return for a portfolio must be between the lowest expected return for a security in the portfolio and the highest expected return for a security in the portfolio. The exact position depends upon the weights of each of the securities. 77. Markowitz was the first to formally develop the concept of portfolio diversification. He showed quantitatively why, and how, portfolio diversification works to reduce the risk of a portfolio to an investor. In effect, he showed that diversification involves the relationships among securities....
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 Spring '11
 Moore
 Variance

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