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    Portfolios of One Risky Asset and A Risk Free Asset 1

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    Shrestha Surya
    This document discusses portfolios consisting of one risky asset and a risk-free asset. It defines expected return as a probability-weighted average of possible returns. The standard deviation measures a portfolio's risk, with higher standard deviation indicating greater uncertainty of outcomes. For a portfolio with one risky asset and a risk-free asset, the expected return is calculated as the weighted average of the risky asset's expected return and the risk-free rate, where the weight given to the risky asset depends on the portfolio and risky asset's standard deviations. The document provides an example calculation to illustrate these concepts.

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    Portfolios of One Risky Asset and A Risk Free Asset 1

    Uploaded by

    Shrestha Surya
    78 views6 pages
    This document discusses portfolios consisting of one risky asset and a risk-free asset. It defines expected return as a probability-weighted average of possible returns. The standard deviation measures a portfolio's risk, with higher standard deviation indicating greater uncertainty of outcomes. For a portfolio with one risky asset and a risk-free asset, the expected return is calculated as the weighted average of the risky asset's expected return and the risk-free rate, where the weight given to the risky asset depends on the portfolio and risky asset's standard deviations. The document provides an example calculation to illustrate these concepts.

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    Investment Analysis

    Original Title

    BUS 624-PA1

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    This document discusses portfolios consisting of one risky asset and a risk-free asset. It defines expected return as a probability-weighted average of possible returns. The standard deviation measures a portfolio's risk, with higher standard deviation indicating greater uncertainty of outcomes. For a portfolio with one risky asset and a risk-free asset, the expected return is calculated as the weighted average of the risky asset's expected return and the risk-free rate, where the weight given to the risky asset depends on the portfolio and risky asset's standard deviations. The document provides an example calculation to illustrate these concepts.

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    78 views6 pages

    Portfolios of One Risky Asset and A Risk Free Asset 1

    Uploaded by

    Shrestha Surya
    This document discusses portfolios consisting of one risky asset and a risk-free asset. It defines expected return as a probability-weighted average of possible returns. The standard deviation measures a portfolio's risk, with higher standard deviation indicating greater uncertainty of outcomes. For a portfolio with one risky asset and a risk-free asset, the expected return is calculated as the weighted average of the risky asset's expected return and the risk-free rate, where the weight given to the risky asset depends on the portfolio and risky asset's standard deviations. The document provides an example calculation to illustrate these concepts.

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    © All Rights Reserved
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    of 6

    PORTFOLIOS OF ONE RISKY ASSET AND A RISK FREE ASSET 1

    Portfolios of one risky asset and a risk-free asset

    Surya Shrestha

    Westcliff University

    BUS 624 INVESTMENT ANALYSIS

    Professor: Som P. Pudasaini

    September 17, 2017


    PORTFOLIOS OF ONE RISKY ASSET AND A RISK FREE ASSET 2

    Introduction

    People investment their capital in different project with the hope that they will get some

    income or return or their capital will appreciate in the future. These people fall under two

    categories to take care of risk for creating investment portfolio. One people may be risk taker or

    love to take risk and concerned about the rates of return on their investment. They don’t care

    about risk for investing in stock or commodities and make themselves ready for taking high risk

    in order gains high rates of return on their investment. Risk taker investors shows high tolerance

    for the risk and strong desire to earn high rate of return on their investment (Wen, He, & Chen,

    2014).

    On the other hands, other investors fall under risk averse who frequently choose the

    investment with low risk or risk-free investment. They give more important to the amount of

    risk rather than the rate of return on their investment. A risk averse investors neglect to add high

    risk securities on their portfolio. Risk averse investors shows defensive investment strategies

    and interest for investing in defensive stock or debt instruments such as notes, bonds, debentures,

    certificates and so on.

    The expected rate of return for individual asset can be defined as the sum of probability-weight

    average of the rates of return from given daily or monthly or quarterly or yearly prices of the

    stock (French, Schwert, & Stambaugh, 1987). Mathematically, the expected return can be

    calculated as,

    Where, p(s) is the probability of given each scenario, r(s) the return of given scenario.

    For one assets,


    PORTFOLIOS OF ONE RISKY ASSET AND A RISK FREE ASSET 3

    The expected return be defined as mean of the return of given assets.

    For two assets,

    E(r) = W1R1 + W2 R2

    Tools for Measuring risk

    Standard Deviation

    The standard deviation of the rate of return measure the risk of the individual asset or

    portfolio. The square root of the variance also called standard deviated and equal to sum of the

    expected value of the squared deviations from the expected return (Bondie, Kane, & Marcus,

    2014). The higher the volatility in outcomes, the higher will be the average value of these square

    deviations and provide one measure of the uncertainty of outcomes. Mathematically, the

    Variance can show as below,

    Coefficient of Variances

    Coefficient of Variances is defined ratio between the standard deviation and mean. It is

    used to compare relative risk of given dispersion data.

    Portfolios of one Risky Asset and a Risk-Free Asset


    PORTFOLIOS OF ONE RISKY ASSET AND A RISK FREE ASSET 4

    In the given graph, x-axis shows the expected return and y-axis shows the standard deviation of

    the portfolio. The expected return of portfolio can be calculated as,

    Where, y is the weight of the risky portfolio and 1-y is the weight of the risk-free asset.

    Also,

    The weight of the risky portfolio is calculated as, y = σC / σp

    Numerical data,

    Given,

    Risk free rate (rf) 12%

    Rate of return on the risky portfolio (rp) = 30%

    Standard deviation on the risky portfolio (σp) = 40%

    Standard deviation on the complete portfolio σC = 30


    PORTFOLIOS OF ONE RISKY ASSET AND A RISK FREE ASSET 5

    Weight of the risky portfolio (y) = ?

    Expected rate of return of portfolio (rC) = ?

    Now,

    We have,

    y= σC / σp = 0.30/0.40 = 0.75.

    Also,

    Expected rate of return of portfolio,

    = 0.12 + 0.75 {0.30 -0.12}

    = 25.50%

    Therefore, we have the expected rate of return of portfolio equal to 25.5%. In addition, the

    portfolio is expected to earn a proportion, y, of the risk premium of the risky portfolio, E(rp) – rf.

    The investors are assumed risk averse and unwilling to take a risky position without a positive

    risk premium.
    PORTFOLIOS OF ONE RISKY ASSET AND A RISK FREE ASSET 6

    References

    Bondie, Z., Kane, A., & Marcus, A. J. (2014). Investment (10th ed.). New York: McGraw-Hill.

    French, K. R., Schwert, G. W., & Stambaugh, R. F. (1987). Expected stock returns and volatility.

    Journal of Financial Economics, 19(1), 3-29.

    Wen, F., He, Z., & Chen, X. (2014). Investors' risk preference characteristics and conditional

    skewness. Mathematical Problems in Engineering, 1-14.

    doi:http://dx.doi.org/10.1155/2014/814965

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