Portfolio return , risk and related concepts

1.Portfolio return
Portfolio return is the overall return on the entire portfolio. For example : A portfolio comprises two securities a 40% and security b 60%. If the return on security a is 8 % and b 6% then portfolio return will be: !40% " 8%# $ !60%"6%# % 6.8% &he above can be 'iven by the formula: R p= X a R a X b R b (here )p % portfolio return "a% proportion for security a "b% proportion for security b )a % return on security a )b% return on security b &hus the portfolio return is the wei'hted avera'e return of the returns in the individual securities.

2. Portfolio risk
Risk measurement in a two security portfolio

Risk of security a (a)

Risk of Security b (b)

Portfolio risk (p)

When securities are perfectly correlated

W hen securities are not perfectly correlated

When securities are perfectly positively correlated (+1)

When securities are perfectly negatively correlated (-1)

When securities have zero correlation

The objective of the whole exercise is to deter

ine the opti

portfolio based

on the return and ris! profile of various given portfolios"

Portfolio risk is measured by the following formulae: A) (hen securities are not perfectly correlated:*

 p = [ X a a , X b b , ,"a X b a b ]
(here - % standard deviation of return on the portfolio - a % standard deviation of return on security a - b % standard deviation of return on security b - ab% covariance of return on security a and security b "a% proportion for security a "b% proportion for security b In the above e.ample if -a% 0.,% -b% 0./% and -ab !covariance ab# % 0% what would be the ris12

p = [ 4 0 % x 0., %, 6 0 % x 0./ %, ,.40 % x 6 0 % x 0 %] % +0.6,%

B) (hen securities are perfectly correlated:* +. when the correlation coefficient is $+ the formula is: p = X a a X b b ,. when the correlation coefficient is *+ the formula is: p = X a a X b b Six portfolio case of Return and Risk: 3rom the followin' data calculate the return and ris1 for different levels of security a in the portfolio:

return in security a 6% return in security b 8%

!)a# !)b#

standard deviation of security a % 0.,% !- a# standard deviation of security b % 0./% !- b# 4orrelation coefficient is : $+ 0 and *+

5ifferent levels of security in the portfolio are: ,0% 00% 60% 60% and +00%. Solution: Portfolio returns for different levels of security a and b

Proportion of securities in the portfolio 7ecurity a !)a 6%# !"a# !"b# 0.00 0.,0 0.00 0.60 0.60 +.00 +.00 0.60 0.00 0.40 0.,0 0.00 0 +.00 /.00 /.60 4.00 6.00

7ecurity b !)b 8%# 8.00 6.00 4.00 /.,0 ,.00 0.00

Portfolio return !)p# 8.00 6.00 6.00 6.80 6.00 6.00

Portfolio risk for different levels of security a and b Proportion of securities "a 0.00 0.,0 0.00 0.60 0.60 +.00 "b +.00 0.60 0.00 0.40 0.,0 0.00 ! 0./0 0.,8 0.,0 0.,4 0.,/ 0.,0 4orrelation co*efficient " 0./0 0.,/ 0.+8 0.+6 0.+6 0.,0 #! 0./0 0.+8 0.00 0.00 0.08 0.,0

8. A portfolio consistin' of two assets A and 9 has overall e.pected return of 6.8%. Assets A and 9 have wei'hta'e of 40% and 60% respectively. If the return on asset 9 is 8% find out the return on Asset A..