Note_04M.21-27

Note_04M.21-27 - 21 Case 2. Two risky assets Following the...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
21 Case 2. Two risky assets Following the same procedure as in case 1, we allocate fraction of fund to risky asset 1 and fraction of fund to risky asset 2. The rate of return on portfolio is and its mean and variance are Both the mean and variance are affected by allocation weights and . The relation between and that describes the PPC can be derived as follows. (i) solve the mean equation for to derive (ii) Substitute these expressions into the variance equation Though this expression is complicated and is not very useful for our purpose, it shows that the PPC is a hyperbola in and . Two cases need a special attention. The equation for the PPC in the case of a perfectly correlated returns ( D =±1) becomes a simple equation. Perfect Positive Correlation ( D =+1) Perfect Negative Correlation ( D =-1). (i)
Background image of page 1

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

View Full DocumentRight Arrow Icon
(ii) If , the portfolio has a zero risk ( ). Proof. (A) Perfect Positive Correlation ( D =+1). The portfolio possibility curve is a straight line. In this case, the variance equation becomes which gives Solving this for , we can write Substituting this into the equation for the mean return we have And this is a linear equation in the and space, and the PPC is a straight line connecting point A and point B . (B) Perfect Negative Correlation (
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 7

Note_04M.21-27 - 21 Case 2. Two risky assets Following the...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online