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W1 = Proportion of funds in Security 1
W2 = Proportion of funds in Security 2
r1 = return on Security 1
r2 = return on Security 2
E(): expected return
rp = W1r1 + W2r2

E(rp) = W1E(r1 ) + W2E(r2 )

O

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12 = Variance of Security 1

22 = Variance of Security 2
Cov(r1r2) = Covariance of returns for
Security 1 and Security 2
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Cov(r1r2) = w 12
1,2 = Correlation coefficient of
returns
1 = Standard deviation of returns for
Security 1
2 = Standard deviation of returns for
Security 2
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+ 1.0 >  > -1.0
If = 1.0, the securities would be perfectly
positively correlated
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perfectly negatively correlated
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9 m9
(ri - rf) = Ô i + ßi(rm - rf) + ei
isk Prem Market isk Prem
or Index isk Prem
ҏÔ = the stock¶s expected return if the
i
market¶s excess return is zero (rm - rf) = 0
ßi(rm - rf) = the component of return due to
movements in the market index
ei = firm specific component, not due to market
movements
*
Y +  

üet: i = (ri - rf) isk premium

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