lecture 10 Flashcards
computing portfolio expected returns formula
E(Rp) = wb * E(Rb) + ws * E(Rs)
computing portfolio variance
cov(Rb,Rs)/sigmab*sigmas
or
𝝈𝑷^2 = 𝒘𝒃^𝟐𝝈𝒃^𝟐 + 𝒘𝒔^𝟐𝝈𝒔^𝟐 + 𝟐 (𝒘𝒃𝝈𝒃) *(𝒘𝒔𝝈𝒔 𝝔)𝒃𝒔
The sources of risks
market risk (also called non diversifiable risk, systematic risk)
Attributable to marketwide risk sources
Firm specific risk: (idiosyncratic risk, diversifiable risk, unique risk or non systematic risk)
Risk is the firm specific and the sources of risk are independent
why to invest international stocks
investors can reduce portfolio risk more by holding international securities more
The less correlated the securities in a portfolio, the lower the portfolio risk
Security returns are substantially less correlated across countries than within a country because
Economic political institutional and even psychological factors affecting security returns tend to vary across countries
why invest in international stocks
beta: denotes the systematic risk beta of a countrys stock market index measured against world stock market index
E.g. NL beta = 1.07
SHP: Denotes the sharpe performance measure which is:
(Ri - Rj)/omegaf where Ri and omegai are respectively the mean and standard deviation of returns for the ith market
Sharpe performance measure is provided in parentheses
The optimal international portfolio
Has the highest possible sharpe ratio
The OIP can be solved by maximizing the sharpe ratio with respect to the portfolio weights
SHPi = (E(Rp)-Rf)/omegap
THis is called risk adjusted performance measure
why sharpe ratio
to earn the highest possible expected returns for any level of volatility we must find the portfolio that generates the steepest possible line when combined with the risk free investment
Sharpe ratio is a reward to risk ratio (formula)
E(r) - rf/omega
portfolio excess return/portfolio volatility
the world beta
measures the sensitivity of a national market to world market movements
In other words the world beta is defined as
Betai = cov(Rworld,Ri)/omega^2world
