Module 4 - Risk & Return on a Portfolio Flashcards
For a two asset portfolio, Weight of share A is…?
W(A) = (1 - W(B))
What is the variance of a portfolio dependent on?
The way in which the return of shares A and B move with each other.
What is the name for the way in which it is best to express the relationship between two variables?
Covariance.
How is covariance calculated?
Cov (A,B) = σAB = ΣPi (R(A)i - R(A) ) - (R(B)i - R(B)
What is the correlation coefficient?
The normalised deviation of the two individual variables.
How do you calculate correlation?
Cor = σAB / σA * σB
How do you calculate portfolio variance?
σp² = WA²σA² + WB²σB² + 2WAWBσAB
How do you calculate the portfolio mean?
Rp = W(A)R(A) + W(B)R(B)
The variance of a portfolio is a function of what?
The weights.
How can portfolio variance be reduced (or increased)?
By varying the weights in which the shares are held, the investment-opportunity line.
Describe the efficient frontier.
The portion of the line that is dotted will never be desired by investors because they can always get more return for the same level of risk. The portion of the line that is continuous is the efficient frontier.
A portfolio is on the efficient frontier if…?
1) No other portfolio offers the same expected return but has a lower standard deviation.
2) No other portfolio has the same standard deviation but offers a higher expected return.
The efficient frontier has at its left extremity …?
The minimum variance portfolio.
The efficient frontier has at its right extremity …?
The single asset offering the highest expected return.
How would you calculate a two share minimum variance portfolio (MVP)?
WA = (σB² - σAσBρAB) / (σA² + σB² - 2σAσBρAB)
