Similarly if the portfolio invested 100 in nokia the

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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 risk-return space. The outcome of this plot is the collection of all such possible portfolios, which defines a region in the risk-return 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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