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Portfolio MGMT Theory
Portfolio MGMT Theory
Definitions:
Assets by definition are expected to have positive cash flow(s). For Instance: The cash
flow of a bond is coupon payments, and the cash flow of a tock is dividends or price
appreciation. A portfolio is a combination of 2 or more assets (stocks, bonds, real estate,
contracts, currency, etc) Price of any assets by definition is the present value of all its future cash
flows. For Example: The price of a bond is the present value of all its future cash flows (coupon payments
and bonds Face Value)
Rp = X1K1 + X2K2
Stock-1 (X)
2
3
6
-4
8
Stock-2 (Y)
4
-2
8
-4
4
X = 3
Var(X) = 21
2= Y
24 = Var(Y) and Cov(X,Y) = 17
Rp = X1K1 + X2K2
Rp = X1(3) +X2(2)
Rp = 3X1 + 2(1-X1)
Rp = 3X + 2 - 2X1
Rp = 2 + X1
X1 = 64%
X2 = 36%
Return of the MVP is Rp = 2 +.64 = 2.64%
= 11 X12 - 14 X1 + 24
= 11 (.64)2 - 14 (.64) + 24
= 19.55
St. Dev(p) = 4.42%
Var(P)
K1 = .05 |
K2 = .07 |
K3 = .3 |
Var(1) = .1
Var(2) = .4
Var(3) = .7
Cov(1,2) = - .1
Cov(1,3) = 0
Cov(2,3) = .3
Rp =
=
=
X1 K1 + X2 K2 + X3 K3
.05 X1 +.07 X2 + (1-X1-X2) (.3)
-.25X1 - .23X2 + .3
Var(P)
* X1 + X2 + X3 = 1
X2 + .6 X1 - .8 = 0 ==> X2 = .8 - .6 X1
1.6 X1 + .6 X2 -1.4 = 0
1.6 X1 + .6(.8-.6X1 ) - 1.4 = 0 ==> X1 = 74.2%
X2 = .8 - .6(.742) = 35.5%
X3 = -9.7%
Characteristics of MinimumVariance Portfolio (MVP):
X1 = 74.2%
X2 = 35.5%
X3 = - 9.7%
Rp = -.25 X1 - .23 X2 + .3
= -.25 (74.2%) - .23 (35.5%) + .3
= 3.29%
Var(P) = .8 X12 + .5 X22 - 1.4 X1 - .8 X2 + .6 X1 X2 + .7
= .8 (74.2%)2 + .5 (35.5%)2 - 1.4 (74.2%) - .8 (35.5%) + .6 (74.2%) (35.5%) + .7
= .0287