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    Risk and Return

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    MD Hafizul Islam Hafiz
    This document discusses portfolio risk and return. It explains that a portfolio's risk depends on the interplay between the returns of its individual assets, unlike return which is simply the weighted average. It also describes how adding a risk-free asset like cash creates an efficient frontier where risk and expected return have a linear relationship, dominating portfolios without the risk-free component. The fraction invested in the risk-free versus risky assets determines the complete portfolio's expected return and standard deviation.

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    Risk and Return

    Uploaded by

    MD Hafizul Islam Hafiz
    22 views11 pages
    This document discusses portfolio risk and return. It explains that a portfolio's risk depends on the interplay between the returns of its individual assets, unlike return which is simply the weighted average. It also describes how adding a risk-free asset like cash creates an efficient frontier where risk and expected return have a linear relationship, dominating portfolios without the risk-free component. The fraction invested in the risk-free versus risky assets determines the complete portfolio's expected return and standard deviation.

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    Special issue in corporate finance

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    This document discusses portfolio risk and return. It explains that a portfolio's risk depends on the interplay between the returns of its individual assets, unlike return which is simply the weighted average. It also describes how adding a risk-free asset like cash creates an efficient frontier where risk and expected return have a linear relationship, dominating portfolios without the risk-free component. The fraction invested in the risk-free versus risky assets determines the complete portfolio's expected return and standard deviation.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    22 views11 pages

    Risk and Return

    Uploaded by

    MD Hafizul Islam Hafiz
    This document discusses portfolio risk and return. It explains that a portfolio's risk depends on the interplay between the returns of its individual assets, unlike return which is simply the weighted average. It also describes how adding a risk-free asset like cash creates an efficient frontier where risk and expected return have a linear relationship, dominating portfolios without the risk-free component. The fraction invested in the risk-free versus risky assets determines the complete portfolio's expected return and standard deviation.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 11

    RISK AND RETURN OF PORTFOLIO

    • A portfolio means a combination of two or more securities (assets). A


    large number of portfolios can be formed from a given set of assets.
    Each portfolio has risk-return characteristics of its own. Portfolio
    theory, originally developed by Harry Markowitz, shows that
    portfolio risk, unlike portfolio return, is more than a simple
    aggregation of the risks of individual assets. This depends on the
    interplay between the returns on assets comprising the portfolio. As
    investors construct a portfolio of investment rather than invest in a
    single asset, this Section extends the analysis of risk and return
    associated with portfolio investments.
    Portfolio Expected Return
    • The expected rate of return on a portfolio is the weighted average of
    the expected rates of return on assets comprising the portfolio. The
    weights, which add up to 1, reflect the fraction of total portfolio
    invested in each asset. Thus, there are two determinants of portfolio
    return: expected rate of return on each asset and the relative share of
    each asset in the portfolio. Symbolically, the expected return for a n-
    asset portfolio is defined by Equation
    Portfolio Expected Return
    Portfolio Expected Return
    Portfolio Risk (Two-Asset Portfolio)
    Portfolio Risk (Two-Asset Portfolio)
    Portfolio Risk (Two-Asset Portfolio)
    Efficient Frontier with One Risk-free Asset
    • Efficient Frontier with One Risk-free Asset A risk-free security is one
    that has zero variance and, hence, standard deviation (square root of
    variance). James Tobin has pointed out that: (a) Portfolios made up of
    risky assets and one risk-free asset generate investment opportunities
    (portfolio opportunity set) with linear relationship between expected
    return and risk; (b) One such portfolio opportunity set will dominate
    the portfolios formed by mixing only risky assets (securities and/or
    portfolios of securities/other assets). To facilitate further discussion, let
    us denote a risk-free portfolio by F, a risky portfolio by M, and a
    complete portfolio formed by combining them as C. Further, w is the
    fraction of the overall portfolio invested in M, and the remaining (= 1 –
    w) in F. The expected return of the complete portfolio may be calculated
    by using Equation
    Efficient Frontier with One Risk-free Asset
    • E(rc) = rf + w[E(rm) – rf ]
    • where E(rc) = Expected rate of return on complete portfolio
    • rf = Risk-free rate of return
    • w = Fraction of complete portfolio, C, invested in risky asset M
    • E(rm) = Expected return for risky asset M
    • E(rm) – rf = Risk premium of the risky portfolio
    • The standard deviation of the complete portfolio is given by:
    Efficient Frontier with One Risk-free Asset
    Efficient Frontier with One Risk-free Asset

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