Professional Documents
Culture Documents
• Return
diversification
Computation of
1) Single period returns and
2) Multi period returns
Measurement of
1) Historical Returns and
2) Expected Return of a security as well as portfolio
RISK
t =1
=
n -1
PERIOD RETURN DEVIATAION SQUARE OF DEVIATION
Ri (Ri - R) (Ri - R)2
1 15 5 25
2 12 2 4
3 20 10 100
4 -10 -20 400
5 14 4 16
6 9 -1 1
Ri = 60 (Ri - R)2 = 536
R = 10
(Ri - R)2
2 = = 107.2 = [107.2]1/2 = 10.4
n -1
MEASURING EXPECTED (EX ANTE)
RETURN AND RISK
EXPECTED RATE OF RETURN
n
E (R) = pi Ri
i=1
STANDARD DEVIATION OF RETURN
= [ pi (Ri - E(R) )2]
+
••
••
Thus the covariance between the returns on the two assets is 26.0.
CO EFFIENT OF CORRELATION
Cov (Ri , Rj)
Cor (Ri , Rj) or ij =
(Ri , Rj)
ij
=
i j
ij = ij . i . j
where ij = correlation coefficient between the returns on
securities i and j
ij = covariance between the returns on securities
i and j
i , j = standard deviation of the returns on securities
i and j
PORTFOLIO RISK : 2 – SECURITY CASE
1 = 10%, 2 = 16%
12 = 0.5
p = [0.62 x 102 + 0.42 x 162 +2 x 0.6 x 0.4 x 0.5 x 10 x 16]½
= 10.7%
p = [ wi wj ij i j ] ½
Example : w1 = 0.5 , w2 = 0.3, and w3 = 0.2
1 = 10%, 2 = 15%, 3 = 20%
12 = 0.3, 13 = 0.5, 23 = 0.6
p = [w12 12 + w22 22 + w32 32 + 2 w1 w2 12 1 2
+ 2w2 w3 13 1 3 + 2w2 w3 232 3] ½
= [0.52 x 102 + 0.32 x 152 + 0.22 x 202
+ 2 x 0.5 x 0.3 x 0.3 x 10 x 15
+ 2 x 0.5 x 0.2 x 05 x 10 x 20
+ 2 x 0.3 x 0.2 x 0.6 x 15 x 20] ½
= 10.79%
RISK OF AN N - ASSET PORTFOLIO
2p = wi wj ij i j
n x n MATRIX
1 2 3 … n
: : :
n wnw1ρn1σnσ1 wn2σn2
MEASUREMENT OF SYSTEMATIC RISK
CALCULATION OF BETA
Beta– It is the share’s sensitivity to market movements. In simple words, It indicates how much the
scrip moves for the unit change in the market index. It can be positive or negative. Negative beta
indicates that the share moves in the opposite direction of the market
iM
i =
M 2
CALCULATION OF BETA
Square of the
Return on Deviation of Deviation of Product of the
Return on deviation of
Period market return on stock A return on market deviation,
stock A, RA return on market
portfolio, RM from its mean portfolio from its (RA - RA)
portfolio from its
(RA - RA) mean (RM - RM) (RM - RM)
mean
(RM - RM)2
1 10 12 0 3 0 9
2 15 14 5 5 25 25
3 18 13 8 4 32 16
4 14 10 4 1 4 1
5 16 9 6 0 0 0
6 16 13 6 4 24 16
7 18 14 8 5 40 25
8 4 7 -6 -2 12 4
9 -9 1 -19 -8 152 64
10 14 12 4 3 12 9
11 15 -11 5 -20 -100 400
12 14 16 4 7 28 49
13 6 8 -4 -1 4 1
14 7 7 -3 -2 6 4
15 -8 10 -18 1 -18 1
RA = 150 RM = 135 (RA - RA) (RM - RM) 2
RA =10 RM = 9 (RM - RM) = 221 = 624
So Beta = 221/624 =.3541
SECURITY MARKET LINE
E(RM) - Rf
E(Ri ) = Rf + CiM
M
iM
βi =
M
E (R i ) = R f + [ E (R M) - R f ] β i
EXPECTED •P
RETURN SML
14%
8% •0
1.0 β
Important practical applications of Security Market Line –