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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- Spring '12