Professional Documents
Culture Documents
Presented by
Prof. Eduardus Tandelilin, CWM
“Put all your eggs in the one basket and
WATCH THAT BASKET!” -- Mark Twain
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PORTFOLIO RISK
Rate of Return Distribution
Two (W&M) stocks with perfect negative correlation (r = -1.0)
and for portfolio WM
a. Rates of Return
Stock W Stock M Portfolio WM
25 25 25
15 15 15
0 0 0
2003 2003 2003
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b. Probability Distributions of Return
Percent
0 15 Percent 0 15 Percent 0 15
kw kM kP
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Portfolio WM – kP
Year W – kW (%) M - kM (%)
(%)
1999 40.0 -10.0 15.0
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PORTFOLIO RISK
Rate of Return Distribution
Two (M&M’) stocks with perfect positive correlation (r = +1.0)
and for portfolio MM’
c. Rates of Return
Stock M Stock M’ Portfolio MM’
25 25 25
15 15 15
0 0 0
2003 2003 2003
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d. Probability Distributions of Return
kM kM’ kP
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Portfolio MM’ - kP
Year M - kM (%) M’– kM’ (%)
(%)
1999 -10.0 -10.0 -10.0
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PORTFOLIO RISK
Rate of Return Distribution
Two (W&Y) stocks with partial correlation (r = +0.65)
and for portfolio WY
e. Return
Stock W Stock Y Stock WY
kW (%) kY (%) kWY (%)
25 25
25
15 15 15
0 0 0
2003 2003 2003
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f. Probability Distributions of Return
Probability Density
Portfolio WY
Stock W and Y
0 15 Percent
kP
10
Portfolio WY - kP
Year W - kW (%) Y – kY (%)
(%)
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Average Return and Volatility For Portfolios
Portfolio Expected Return
0.025
0.020 50% WIRELESS + 50%
REINSURANCE 100% WIRELESS
0.015 TELECOM GROUP
50% WIRELESS + 50%
0.010 IMMUCELL
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Two-Asset Portfolio Standard
Deviation
p w1 1 w2 2 2w1 w2 12 1 2
2 2 2 2 2
Standard Deviation p
2
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Correlation of Reinsurance Group,
Immucell, and Wireless
Relative Performance of Three Stocks
2
January 2000
1.5
0.5
0
January 2000 - December 2002
Reinsurance Group Immucell Corp. Wireless Telecom
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Correlation Coefficients And Risk
Reduction For Two-Asset Portfolios
Expected Return on the Portfolio
25%
-1.0 < <1.0
20%
15% is +1.0
is -1.0
10%
15
Variance – Covariance Matrix
Asset 1 2 3 4 5
1 2 2 2 2 2
1 1 2 1 1 1 1
1 12 13 14 15
5 5 5 5 5
2
2 2 2 2 2 2
1 1 2 1 1 1
21 2 23 24 25
5 5 5 5 5
3
3 2 2 2 2 2
1 1 1 2 1 1
31 32 3 34 35
5 5 5 5 5
4
4 2 2 2 2 2
1 1 1 1 2 1
41 42 43 4 45
5 5 5 5 5
5 2 2 2 2 2
5 1 1 1 1 1 2
51 52 53 54 5
5 5 5 5 5
Diversifiable Risk
Total risk
Nondiversifiable Risk
1 5 10 15 20 25
Number of Securities (Assets) in Portfolio
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Illustration of Portfolio Returns, Risk,
and the Attainable Set of Portfolios
a. Returns b. Risk c. Attainable Set of Risk/Return Combinations
Expected
Return, kP
Case I: Percent (%)
B=10
rAB = +1.0 kB=8
kP P
8 B
kA=5
A=4 5 A
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CHOOSING THE OPTIMAL PORTFOLIO
THE EFFICIENT SET OF INVESTMENT
Expected Portfolio
Return, kP
E
D
C G
X
Feasible, or
B Attainable Set
H
Risk, P (%)
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RISK/RETURN INDIFFERENCE CURVES
Expected Rate of Return, rP
IY
10
9 IZ
8
7
Y’s Risk Premium (RP) for
6 Risk = P = 3.3%; RPY = 2.5%
5
Z’s Risk Premium (RP) for
4
Risk = P = 3.3%; RPZ = 1.0%
3
2
1
0 1 2 3 4 5 6 7 8 9 Risk, p(%)
20
SELECTING OPTIMAL PORTFOLIO OF RISKY ASSET
B
8
7.2
7
A
6
2 4 6 8 10
4.2 7.1
Risk, p(%)
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THE CAPITAL MARKET LINE
Investors Equilibrium: Combining the Risk Free Asset with the Market Portfolio
Expected Rate of
Return, kP Increasing utility
I3 Z
I2 I1
E
kM
M
N
G
B
H
kP
R
A
kRF
P M Risk, P
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CAPITAL MARKET LINE (CML)
Expected Rate of
Return, kP
(k̂ M - k RF )
CML k̂ p k RF P
σ M
k̂ M M
k̂ RF
0 M Risk, P
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Thank You..
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