Unformatted text preview: Risk, return and opportunity cost of capital If the portfolio invested 100% in Nestlé the expected return would be 10% with a standard deviation of
20%. Similarly, if the portfolio invested 100% in Nokia the expected return would be 15% with a standard
deviation of 30%. However, a portfolio investing 50% in Nokia and 50% in Nestlé would have an
expected return of 12.5% with a standard deviation of 21.1%. Note that the standard deviation of 21.1% is
less than the average of the standard deviation of the two stocks (0.5 · 20% + 0.5 · 30% = 25%). This is
due to the benefit of diversification.
In similar vein, every possible asset combination can be plotted in riskreturn space. The outcome of this
plot is the collection of all such possible portfolios, which defines a region in the riskreturn space. As the
objective is to minimize the risk for a given expected return and maximize the expected return for a given
risk, it is preferred to move up and to the left in Figure 4.
Figure 4: Portfolio th...
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 Spring '12
 

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