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Definitions:
Assets by definition are expected to have positive cash flow(s). For Instance: The cash flow of a bond is coupon payments, and the cash flow of a tock is dividends or price appreciation. A portfolio is a combination of 2 or more assets (stocks, bonds, real estate, contracts, currency, etc) Price of any assets by definition is the present value of all its future cash
flows. For Example: The price of a bond is the present value of all its future cash flows (coupon payments and bonds Face Value)
Rp = X1K1 + X2K2
Stock-1 (X) 2 3 6 -4 8 Stock-2 (Y) 4 -2 8 -4 4
X = 3 Var(X) = 21
Rp = X1K1 + X2K2
Rp = X1(3) +X2(2) Rp = 3X1 + 2(1-X1) Rp = 3X + 2 - 2X1 Since X1+ X2 = 1 X2 = 1-X1
Rp = 2 + X1
X1 = 64% X2 = 36% Return of the MVP is Rp = 2 +.64 = 2.64% = 11 X12 - 14 X1 + 24 = 11 (.64)2 - 14 (.64) + 24 = 19.55 St. Dev(p) = 4.42% Var(P)
Rp = = = Var(P)
= X12 (.1) + X22 (.4) + X32 (.7) + 2 X1 X2 (-.1) + 2 X2X3 (.3) = .1 X12 + .4 X22 + .7 (1-X1-X2)2 - .2 X1 X2 + .6 X2 (1-X1-X2)
= .1 X12 + .4 X22 + .7 (1-(X1+X2))2 - .2 X1 X2 + .6 X2 - .6 X1 X2 - .6 X22 = .1 X12 - .2 X22 + .7 (2(-X1-X2) + (X1+X2)2 +1) - .2 X1 X2 + .6 X2 - .6 X1 X2 = .1 X12 - .2 X22 + .7 ((-2 X1 - 2 X2 + X12 + 2 X1 X2 + X22) +1) - .2 X1 X2 + .6 X2 - .6 X1 X2 = .1 X12 - .2 X22 -1.4 X1 - .1.4 X2 + .7 X12 + 1.4 X1 X2 + .7X22 + .7 - .2 X1 X2 + .6 X2 - .6 X1 X2 = .8 X12 + .5 X22 -1.4 X1 -.8 X2 + .6 X1 X2 +.7 Var(P) = .8 X12 + .5 X22 -1.4 X1 -.8 X2 + .6 X1 X2 +.7 X2 + .6 X1 - .8 = 0 ==> X2 = .8 - .6 X1 1.6 X1 + .6 X2 -1.4 = 0 1.6 X1 + .6(.8-.6X1 ) - 1.4 = 0 ==> X1 = 74.2% X2 = .8 - .6(.742) = 35.5% X3 = -9.7% Characteristics of MinimumVariance Portfolio (MVP): X1 = 74.2% X2 = 35.5% X3 = - 9.7% Rp = -.25 X1 - .23 X2 + .3 = -.25 (74.2%) - .23 (35.5%) + .3 = 3.29% Var(P) = .8 X12 + .5 X22 - 1.4 X1 - .8 X2 + .6 X1 X2 + .7 = .8 (74.2%)2 + .5 (35.5%)2 - 1.4 (74.2%) - .8 (35.5%) + .6 (74.2%) (35.5%) + .7 = .0287 Var' (Respect to X2) = Var' (Respect to X1) =