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    Finding A Minimum-Risk Portfolio

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    Bhargavi
    The document discusses finding minimum-risk portfolios for different target rates of return using the Capital Asset Pricing Model. It provides an example calculating the optimal portfolio allocation across three investments that minimizes risk, measured as standard deviation, for different expected returns. It then shows how the optimal portfolios and risks change when the investment returns are correlated rather than independent.

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    Finding A Minimum-Risk Portfolio

    Uploaded by

    Bhargavi
    15 views5 pages
    The document discusses finding minimum-risk portfolios for different target rates of return using the Capital Asset Pricing Model. It provides an example calculating the optimal portfolio allocation across three investments that minimizes risk, measured as standard deviation, for different expected returns. It then shows how the optimal portfolios and risks change when the investment returns are correlated rather than independent.

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    About portfolios

    Original Title

    Portfolios

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    The document discusses finding minimum-risk portfolios for different target rates of return using the Capital Asset Pricing Model. It provides an example calculating the optimal portfolio allocation across three investments that minimizes risk, measured as standard deviation, for different expected returns. It then shows how the optimal portfolios and risks change when the investment returns are correlated rather than independent.

    Copyright:

    © All Rights Reserved
    Download as XLS, PDF, TXT or read online from Scribd
    Download as xls, pdf, or txt
    15 views5 pages

    Finding A Minimum-Risk Portfolio

    Uploaded by

    Bhargavi
    The document discusses finding minimum-risk portfolios for different target rates of return using the Capital Asset Pricing Model. It provides an example calculating the optimal portfolio allocation across three investments that minimizes risk, measured as standard deviation, for different expected returns. It then shows how the optimal portfolios and risks change when the investment returns are correlated rather than independent.

    Copyright:

    © All Rights Reserved
    Download as XLS, PDF, TXT or read online from Scribd
    Download as xls, pdf, or txt
    of 5

    Finding a Minimum-Risk Portfolio

    The example on the next page illustrates the calculations which underlie the
    Capital Asset Pricing Model (CAPM).

    There are three investment alternatives, and our goal is to find, for any
    "target" expected rate of return, the portfolio for which the standard deviation
    of the rate of return on the portfolio (i.e., the value in cell B12) is minimal.

    I've set up "Solver" to solve the minimization problem, To set the target rate
    of return, select the equality constraint in the Solver menu-box, and click on
    "Change".

    I've also tabulated (by invoking Solver 11 separate times) the optimal
    portfolios, and graphed the standard deviation of the rate-of-return of the
    optimal portfolio below the table.

    Note: Don't let the final tab of this workbook frighten you. I built it in order to
    show that the same approach, with a bit more work, can also deal with
    investment opportunities for which the rates of return are not independent.
    Not surprisingly, for any target rate of return, there's somewhat more risk in
    the optimal portfolio than there was in the independent case: The risk can't
    be as fully "diversified away" when the covariances in rates of return are all
    positive.
    Independent Rates of Return

    budget $100.00

    Investment A Investment B Investment C


    E[ROR] 10.00% 12.50% 15.00%
    Stdev[ROR] 3.00% 4.00% 5.00%

    $ invested $32.65 $34.69 $32.65

    E[portfolio ROR] 12.50%


    Stdev[portfolio ROR] 2.36%

    minimum-risk portfolio that achieves minimum


    E[ROR]
    the target expected rate of return stdev(ROR)
    10.00% $100.00 $0.00 $0.00 3.00%
    10.50% $80.00 $20.00 $0.00 2.53%
    11.00% $67.55 $24.90 $7.55 2.29%
    11.50% $55.92 $28.16 $15.92 2.17%
    12.00% $44.29 $31.43 $24.29 2.20%
    12.50% $32.65 $34.69 $32.65 2.36%
    13.00% $21.02 $37.96 $41.02 2.63%
    13.50% $9.39 $41.22 $49.39 2.98%
    14.00% $0.00 $40.00 $60.00 3.40%
    14.50% $0.00 $20.00 $80.00 4.08%
    15.00% $0.00 $0.00 $100.00 5.00%
    E[ROR]

    Risk vs. Rate of Return


    15.00%

    12.50%

    10.00%

    7.50%

    5.00%
    0.00% 1.00% 2.00% 3.00% 4.00% 5.00%
    Stdev(ROR)
    risk-free ROR
    7.00%

    1.000
    1.383
    1.747
    2.072
    2.277
    2.334 market portfolio
    2.283
    2.179
    2.059
    1.839
    1.600

    Data for tangent line


    7.00% 0.00%
    12.50% 2.36%
    18.67% 5.00%
    Correlated Rates of Return
    correlation matrix
    budget $100.00 3.00%
    3.00% 1.00
    Investment A Investment B Investment C 4.00% 0.20
    E[ROR] 10.00% 12.50% 15.00% 5.00% 0.30
    Stdev[ROR] 3.00% 4.00% 5.00%
    covariance matrix
    $ invested $33.55 $32.90 $33.55 A
    A 0.00090
    E[portfolio ROR] 12.50% B 0.00024
    Stdev[portfolio ROR] 3.01% C 0.00045

    minimum-risk portfolio that achieves minimum


    E[ROR]
    the target expected rate of return stdev(ROR)
    10.00% $100.00 $0.00 $0.00 3.00%
    10.50% $80.00 $20.00 $0.00 2.68%
    11.00% $64.92 $30.16 $4.92 2.61%
    11.50% $54.46 $31.07 $14.46 2.66%
    12.00% $44.01 $31.99 $24.01 2.80%
    12.50% $33.55 $32.90 $33.55 3.01%
    13.00% $23.09 $33.81 $43.09 3.29%
    13.50% $12.64 $34.72 $52.64 3.62%
    14.00% $2.18 $35.64 $62.18 3.98%
    14.50% $0.00 $20.00 $80.00 4.42%
    15.00% $0.00 $0.00 $100.00 5.00%
    E[ROR]

    Risk vs. Rate of Return


    15.00%

    12.50%

    10.00%

    7.50%

    5.00%
    0.00% 1.00% 2.00% 3.00% 4.00% 5.00%
    Stdev(ROR)
    correlation matrix
    4.00% 5.00%
    0.20 0.30
    1.00 0.45
    0.45 1.00

    covariance matrix
    B C
    0.00024 0.00045
    0.00160 0.00090
    0.00090 0.00250

    risk-free ROR
    7.00%

    1.000
    1.307
    1.534
    1.693
    1.787
    1.824 market portfolio
    1.822
    1.796
    1.758
    1.698
    1.600

    Data for tangent line


    7.00% 0.00%
    12.50% 3.01%
    16.12% 5.00%

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