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Table of correlations
Asset A Asset B Asset C Things in dark grey are input parameters
Asset A 1.0000 0.3694 0.1539 Things in light grey are computed intermediat
Asset B 0.3694 1.0000 0.2148 Things in yellow are labels
Asset C 0.1539 0.2148 1.0000 Things in red are "Solver" inputs or outputs

Table of expected returns and risk


E(return) Risk
Asset A 20.00% 28.00%
Asset B 18.00% 33.00%
Asset C 33.00% 40.00%

Table of covariances
Asset A Asset B Asset C
Asset A 7.84% 3.41% 1.72%
Asset B 3.41% 10.89% 2.84%
Asset C 1.72% 2.84% 16.00%

Proporition of wealth invested in


Asset A 150.80%
Asset B -111.15%
Asset C 60.34%
Total 1 (this is a CONSTRAINT for "Solver", this cell B23 must be forced to equal one)
(it is the constraint that the total proportions of our wealth must equal one)
This bit is used to find the risk of the portfolio
Asset A Asset B Asset C
Proportion 150.80% -111.15% 60.34% These numbers are a table of, for instance
Asset A 150.80% 17.8294% -5.7210% 1.5685% proportion of A * proportion of B *
Asset B -111.15% -5.7210% 13.4529% -1.9016% covariance of A and B
Asset C 60.34% 1.5685% -1.9016% 5.8260%

Expected return on the portfolio of all 3 assets


30.07% (it you are minimizing risk for a given return you should tell "Solver" that
this cell, B35, is fixed--at whatever level of return you want. If you are maximizing
return for a fixed risk, you should tell "Solver" to maximize this cell

Risk associated with the portfolio of all 3 assets


50.00% (if you are minimizing risk for a given return you should tell "Solver" to minimize
this cell, B40. If you are maximizing return for a fixed risk you should
tell "Solver" that this cell is fixed.)

Now use "solver" to either minimize the risk for a given return
(ie minimize B37 for a prescribed value of B35) or
maximize return for a given risk (ie, maximize B35 for a given
value of B37).
In both cases B23 should be constrained to equal 1, this is the

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condition that our "total wealth" is invested in the assets.

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grey are input parameters


grey are computed intermediate things
w are labels
re "Solver" inputs or outputs

be forced to equal one)


alth must equal one)

s are a table of, for instance


* proportion of B *

d tell "Solver" that


want. If you are maximizing
mize this cell

d tell "Solver" to minimize


isk you should

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Table of correlations
Asset A Asset B Asset C Things in dark grey are input parameters
Asset A 100.00% 36.94% 15.39% Things in light grey are computed intermediat
Asset B 36.94% 100.00% 21.48% Things in yellow are labels
Asset C 15.39% 21.48% 100.00% Things in red are "Solver" inputs or outputs

Table of expected returns and risk on the risky assets


E(return) Risk
Asset A 20.00% 28.00%
Asset B 18.00% 33.00%
Asset C 33.00% 40.00%

Riskfree rate 6.00% The return on the risk free asset

Table of covariances for the risky assets


Asset A Asset B Asset C Construct covariance matrix using formulae
Asset A 7.8400% 3.4133% 1.7237% such as covar(A,B)=risk(A)*risk(B)*correl(A,B)
Asset B 3.4133% 10.8900% 2.8354%
Asset C 1.7237% 2.8354% 16.0000%

Proporition of wealth invested in purely risky assets


Asset A 0.4261 Normally these values are set by "Solver" but it may be necessary to
Asset B 0.0953 reset them to "sensible" values and then re-run "Solver" if "Solver"
Asset C 0.4785 fails to find a solution (eg, B23=1/3, B24=1/3, B25=1/3 )
Total 1.0000 (this is a CONSTRAINT for "Solver", this cell B23 must be forced to equal one)
(it is the constraint that the sum of the proportions of our wealth must equal one)
This bit is used to find the risk of the portfolio of purely risky assets
Asset A Asset B Asset C
Proportion 42.61% 9.53% 47.85% These numbers are a table of, for instance
Asset A 42.61% 1.4237% 0.1386% 0.3515% proportion of A * proportion of B *
Asset B 9.53% 0.1386% 0.0989% 0.1293% covariance of A and B
Asset C 47.85% 0.3515% 0.1293% 3.6640%

Expected return on the portfolio of all 3 risky assets


26.03%

Risk associated with the portfolio of all 3 risky assets


25.35%

Market Price of Risk ( = Slope of the Capital Market Line)


0.79019019

To find the Market Price of Risk (and hence the Capital Market Line)
use "solver" to maximize cell B44 subject to the constraint that
cell B26 is equal to one.
You access "solver" from the "Tools" menu.
grey are input parameters
grey are computed intermediate things
w are labels
re "Solver" inputs or outputs

riance matrix using formulae


A,B)=risk(A)*risk(B)*correl(A,B)

but it may be necessary to


re-run "Solver" if "Solver"
=1/3, B25=1/3 )
be forced to equal one)
our wealth must equal one)

s are a table of, for instance


* proportion of B *
results

Building an efficient frontier using Excel and solver is an inefficient process.


You have to either maximize the return given a level of risk (this is best for large risks and returns)
or minimize the risk for a given level of return (this is best for small risks and returns)
for a lot of possible levels of risk and return. Each specific level of risk or return requires
a separate solver run. This takes a great deal of time.
Below are the results for a three asset model where the expected returns and variance of returns are
E(return) Risk
Asset A 20.00% 28.00%
Asset B 18.00% 33.00%
Asset C 33.00% 40.00%
the covariance matrix is
Asset A Asset B Asset C market price of risk
Asset A 7.84% 3.41% 1.72% risk free rate
Asset B 3.41% 10.89% 2.84%
Asset C 1.72% 2.84% 16.00%
and the correlation matrix is
Asset A Asset B Asset C
Asset A 100.00% 36.94% 15.39%
Asset B 36.94% 100.00% 21.48%
Asset C 15.39% 21.48% 100.00%

efficient frontier
risk return % of asset A % of asset B % of asset C
70.76% 0.00% 100.59% 132.82% -133.41%
65.14% 2.00% 96.14% 123.35% -119.48%
59.59% 4.00% 91.68% 113.88% -105.56%
54.13% 6.00% 87.23% 104.40% -91.63%
48.80% 8.00% 82.77% 94.93% -77.70%
43.62% 10.00% 78.32% 85.46% -63.78%
41.11% 11.00% 76.09% 80.72% -56.81%
38.67% 12.00% 73.86% 75.99% -49.85% short selling
36.31% 13.00% 71.64% 71.25% -42.88%
34.05% 14.00% 69.41% 66.51% -35.92%
31.91% 15.00% 67.18% 61.78% -28.96%
29.92% 16.00% 64.95% 57.04% -21.99%
28.10% 17.00% 62.73% 52.30% -15.03%
26.49% 18.00% 60.50% 47.57% -8.07%
25.13% 19.00% 58.27% 42.83% -1.10%
24.07% 20.00% 56.04% 38.10% 5.86%
23.35% 21.00% 53.82% 33.36% 12.82%
22.99% 22.00% 51.59% 28.62% 19.79% no short selling
23.00% 22.90% 49.60% 24.33% 26.07%
24.00% 24.77% 45.38% 15.51% 39.11%
25.00% 25.75% 43.23% 10.90% 45.87%
26.00% 26.52% 41.58% 7.17% 51.25%
27.00% 27.19% 40.11% 3.97% 55.92%
28.00% 27.80% 38.70% 1.12% 60.17%
29.00% 28.37% 37.53% -1.63% 64.10%
30.00% 28.90% 36.28% -4.11% 67.83%

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results

40.00% 33.40% 26.16% -25.37% 99.21%


50.00% 37.31% 17.43% -43.86% 126.43%
60.00% 41.00% 9.25% -61.38% 152.13%
70.00% 44.59% 1.28% -78.36% 177.08% short selling
80.00% 48.11% -6.46% -95.12% 201.58%
90.00% 51.59% -14.22% -111.60% 225.82%
100.00% 55.04% -21.74% -128.10% 249.85%
110.00% 58.48% -29.41% -144.36% 273.77%
120.00% 61.90% -36.96% -160.61% 297.57%
130.00% 65.31% -44.60% -176.72% 321.32%
140.00% 68.71% -52.13% -192.86% 344.99%
150.00% 72.10% -59.77% -208.87% 368.64%

minimized risk for a given return

maximized return for a given risk

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results

risks and returns)

riance of returns are

0.79019019
6.00%

capital market line


risk return
0.00% 6.00%
4.00% 9.16%
8.00% 12.32%
12.00% 15.48%
16.00% 18.64%
20.00% 21.80%
24.00% 24.96%
28.00% 28.13%
32.00% 31.29%
36.00% 34.45%
40.00% 37.61%
44.00% 40.77%
48.00% 43.93%
52.00% 47.09%
56.00% 50.25%
60.00% 53.41%
64.00% 56.57%
o short selling 68.00% 59.73%
72.00% 62.89%
76.00% 66.05%
80.00% 69.22%
84.00% 72.38%
88.00% 75.54%
92.00% 78.70%
96.00% 81.86%
100.00% 85.02%

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results

104.00% 88.18%
108.00% 91.34%
112.00% 94.50%
116.00% 97.66%
120.00% 100.82%
124.00% 103.98%
128.00% 107.14%
132.00% 110.31%
136.00% 113.47%
140.00% 116.63%
144.00% 119.79%
148.00% 122.95%

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graphs

op set border efficient frontier assets

80%

60%
return

40%

20%

0%
0% 25% 50% 75% 100% 125%

risk

op set border efficient frontier cap market line assets

80%

60%
return

40%

20%

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40%

graphs

20%

0%
0% 25% 50% 75% 100% 125%

risk

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graphs

assets

100% 125% 150%

market line assets

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graphs

100% 125% 150%

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