1. McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Portfolio risk and return measurement Module 5.2

2. 11-1 Portfolio examples  Let us turn now to the risk-return tradeoff of a portfolio that is 50% invested in bonds and 50% invested in stocks.  We can later choose any weights we want across bonds and stocks, just as long as the sum of the weights adds to 1.0

3. 11-2 11.3 The Return and Risk for Portfolios Note that stocks have a higher expected return than bonds and higher risk.

4. 11-3 Portfolios The rate of return on the portfolio is a weighted average of the returns on the stocks and bonds in the portfolio:

5. 11-4 Portfolios The expected rate of return on the portfolio is a weighted average of the expected returns on the securities in the portfolio.

6. 11-5 Portfolios The variance of the rate of return on the two risky assets portfolio is where  BS is the correlation coefficient between the returns on the stock and bond funds.

7. 11-6 Portfolios Observe the decrease in risk that diversification offers. An equally weighted portfolio (50% in stocks and 50% in bonds) has less risk than either stocks or bonds held in isolation.

8. 11-7 Notes: 2-asset portfolio variance  Note that the variance (or standard deviation) is NOT a simple weighted average of the individual asset’s variances (or standard deviations)  Note that the correlation (or covariance) between the asset returns will be a critical determinant of the portfolio’s risk.