# ch07 - 9-1 Lecture III(Chapter 7(7th/8th/9thedition 9-2...

This preview shows pages 1–4. Sign up to view the full content.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: 9-1 Lecture III (Chapter 7 (7th/8th/9thedition)) 9-2 Lecture III – p.2 FIN 6275 The Investment Decision Top-down process with 3 steps: 1.Capital allocation between the risky portfolio and risk-free asset 2.Asset allocation across broad asset classes 3.Security selectionof individual assets within each asset class 9-3 Lecture III – p.3 FIN 6275 rp= W1r1 +W2r2 Wi= Proportion of funds in Security i ri= Expected return on Security i Two-Security Portfolio: Return Matrix format:rp= w’*r 9-4 Lecture III – p.4 FIN 6275 σp2= w12σ12+ w22σ22+ 2w1w2 Cov(r1r2) σi2 = Variance of Security i Cov(r1r2) = Covariance of returns for Security 1 and Security 2 Two-Security Portfolio: Risk Matrix format:σp2= w’*Σ*w here Σrepresents the variance covariance matrix of returns 9-5 Lecture III – p.5 FIN 6275 σ2p = W12σ12 + W22σ12 + 2W1W2 rp= W1r1 +W2r2 + W3r3 Cov(r1r2) +W32σ32 Cov(r1r3) + 2W1W3 Cov(r2r3) + 2W2W3 Three-Security Portfolio 9-6 Lecture III – p.6 FIN 6275 rp= Weighted average of the n securities rp= w’*r σp2 = (Consider all pairwise covariance measures) σp2= w’*Σ*w In General, For an n-Security Portfolio: 9-7 Lecture III – p.7 FIN 6275 Risk Reduction with Diversification Number of SecuritiesSt. DeviationMarket Risk Unique Riskm 9-8 Lecture III – p.8 FIN 6275 The Power of Diversification Remember: If we define the average variance and average covariance of the securities as: We can then express portfolio variance as: σP2=w'Σw=wiwjCov(ri,rj)j=1n∑i=1n∑σ2=1nσi2i=1n∑and Cov=1n(n−1)wiwjCov(ri,rj)i=1n∑j=1j≠in∑σP2=1nσ2+n−1nCov9-9 Lecture III – p.9 Lecture III – p....
View Full Document

{[ snackBarMessage ]}

### Page1 / 9

ch07 - 9-1 Lecture III(Chapter 7(7th/8th/9thedition 9-2...

This preview shows document pages 1 - 4. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online