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10 Portfolio Returns

The document discusses portfolio returns and how to calculate them. It provides properties of random variables that are useful for evaluating portfolio returns, such as how to calculate the expected value and variance of a portfolio. It also discusses how to calculate the expected return, variance, and standard deviation of a portfolio consisting of two assets, using the portfolio weights, expected returns, variances and correlation of the individual assets. An example problem is presented on calculating the expected return of a portfolio with $40,000 invested in Stock A and $60,000 in Stock B, given information about their expected returns and variances.

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Manali Padale
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82 views10 pages

10 Portfolio Returns

The document discusses portfolio returns and how to calculate them. It provides properties of random variables that are useful for evaluating portfolio returns, such as how to calculate the expected value and variance of a portfolio. It also discusses how to calculate the expected return, variance, and standard deviation of a portfolio consisting of two assets, using the portfolio weights, expected returns, variances and correlation of the individual assets. An example problem is presented on calculating the expected return of a portfolio with $40,000 invested in Stock A and $60,000 in Stock B, given information about their expected returns and variances.

Uploaded by

Manali Padale
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 10

MBA 19-21

IMD / OPTS501
Suresh Venkatraman
Pre Reading for class of 14th August

Sunday, August 11, 2019 Portfolio Returns 1 of 10


Portfolio Returns MBA 19-21
IMD / OPTS501
Suresh Venkatraman

◼ Investment opportunities often use both:

❑ Expected return as a measure of reward.


Pre Reading for class of 14th August

❑ Variance or standard deviation of return as a measure of risk.

◼ Portfolio is defined as a collection of assets such as stocks and bonds.

❑ Let X and Y represent two random variables, denoting, say, the


returns of two assets.

❑ Since an investor may have invested in both assets, we would like


to evaluate the portfolio return formed by a linear combination of
X and Y.

Sunday, August 11, 2019 Portfolio Returns 2 of 10


Portfolio Returns MBA 19-21
IMD / OPTS501
Suresh Venkatraman

◼ Properties of random variables useful in evaluating portfolio


returns.
Pre Reading for class of 14th August

❑ Given two random variables X and Y,


◼ The expected value of X + Y is
E ( X + Y ) = E ( X ) + E (Y )
◼ The variance of X + Y is
Var ( X + Y ) = Var ( X ) + Var (Y ) + 2Cov ( X ,Y )
where Cov(X,Y) is the covariance between X and Y.

Sunday, August 11, 2019 Portfolio Returns 3 of 10


Portfolio Returns MBA 19-21
IMD / OPTS501
Suresh Venkatraman

◼ Properties of random variables useful in evaluating portfolio


returns.
Pre Reading for class of 14th August

❑ Given two random variables X and Y, and the constants a, and b


◼ The expected value of aX + bY is

E ( aX + bY ) = aE ( X ) + bE (Y )

◼ The variance of aX + bY is

Var ( aX + bY ) = a2Var ( X ) + b2Var (Y ) + 2abCov ( X ,Y )

where Cov(X,Y) is the covariance between X and Y


Sunday, August 11, 2019 Portfolio Returns 4 of 10
Portfolio weights MBA 19-21
IMD / OPTS501
Suresh Venkatraman

❑ Given a portfolio with two assets, Asset A and Asset B,

❑ the expected return of the portfolio E(Rp) is computed as:


Pre Reading for class of 14th August

E ( Rp ) = w AE ( RA ) + w B E ( RB )

◼ wA and wB are the portfolio weights

◼ such that wA + wB = 1

◼ E(RA) and E(RB) are the expected returns on assets A and B,


respectively.

Sunday, August 11, 2019 Portfolio Returns 5 of 10


Portfolio weights MBA 19-21
IMD / OPTS501
Suresh Venkatraman

❑ Using the covariance or the correlation coefficient of the two


returns, the portfolio variance of return is:
Pre Reading for class of 14th August

Var ( Rp ) = w A 2s A 2 + w B 2s B 2 + 2w Aw B r ABs As B
❑ where s2A and s2B are the variances of the returns for Asset A and
Asset B, respectively,

❑ rAB is the correlation coefficient between the returns for Asset A


and Asset B.

❑ the term rAB σA σB is the covariance between the returns for


Asset A and Asset B
Sunday, August 11, 2019 Portfolio Returns 6 of 10
Stock market problem MBA 19-21
IMD / OPTS501
Suresh Venkatraman

◼ Example: Consider an investment portfolio of $40,000 in


Stock A and $60,000 in Stock B.
Pre Reading for class of 14th August

❑ Given the following information, calculate the expected


return of this portfolio.

Sunday, August 11, 2019 Portfolio Returns 7 of 10


Solution to Stock market MBA 19-21
IMD / OPTS501

problem Suresh Venkatraman


Pre Reading for class of 14th August

Sunday, August 11, 2019 Portfolio Returns 8 of 10


Solution to Stock market MBA 19-21
IMD / OPTS501

problem Suresh Venkatraman

◼ Consider an investment portfolio of $40,000 in Stock A and $60,000 in


Stock B.
Pre Reading for class of 14th August

Calculate the portfolio variance.

❑ Solution:

Sunday, August 11, 2019 Portfolio Returns 9 of 10


Solution to Stock market MBA 19-21
IMD / OPTS501

problem Suresh Venkatraman

◼ Example: Consider an investment portfolio of $40,000 in


Stock A and $60,000 in Stock B.
Pre Reading for class of 14th August

❑ Calculate the portfolio standard deviation.

❑ Solution:

Sunday, August 11, 2019 Portfolio Returns 10 of 10

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