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Basic principles
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Nave Diversification
This type of diversification focus on
selecting the securities that best fit the
needs and desires of investors.
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Markowitz diversification
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E(Rp)= WiE(Ri)
i=1
Where,
E(Rp)=the expected return on portfolio
N= The number of stocks in a portfolio
Wi=The proportion of portfolio invested in stock I
E(Ri)=the expected return on stock i.
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Security
Expected Return,R1%
Proportion X1%
10
25
20
75
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a =4
b =7
Wa =.5
Wb =.5
When coeficient correlation rx= -1
rx = -0.5
rx = 0
rx =1
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Ans: 1.5
Ans:3.04
Ans:4.03
Ans:5.5
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Wa= b/ a + b
=7/4+7
Wa= .64
When Wa = .64
Wb = .36
Therefore when rx= -1
Ans =0
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Expected return%
Proportion %
10
20
15
20
20
60
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E(Ra)=12.5%,E(Rb)=20%, Sda=5.12%,
SDb=20.49% and rab=-1.
Risk of a portfolio consisting of 50% a and
50 % b.
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3. Homogeneous expectations
4. One period investment horizon.
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Achievable Portfolio
Combinations
More Possible Combinations Created
ERp
E is the
minimum
variance
portfolio
Achievable Set of
Risky Portfolio
Combinations
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The highlighted
portfolios are
efficient in that
they offer the
highest rate of
return for a given
level of risk.
Rationale investors
will choose only
from this efficient
set.
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Achievable Portfolio
Combinations
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Achievable Set of
Risky Portfolio
Combinations
Efficient
frontier is the
set of
achievable
portfolio
combinations
that offer the
highest rate
of return for a
given level of
risk.
9 - 26
CHAPTER 9 The Capital
Asset Pricing Model (CAPM)
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B2
T
A2
RF
This is now
called
Clearlythe
RFnew
with
(or
super)
T (the
market
The optimal
efficient
frontier
portfolio)
offers
risky portfolio
of
risky
a series
of
(the market
portfolios.
portfolio
portfolio M)
combinations
Investors can
that dominate
achieve any
those produced
one of these
by RF and A.
portfolio
combinations
Further, they by
borrowing
or but
dominate all
investing
in RF
one portfolio
on
in
thecombination
efficient
with
the market
frontier!
portfolio.
9 - 27
CHAPTER 9 The Capital
Asset Pricing Model (CAPM)
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INVESTMENT
OPPORTUNITY
FUNDAMENTALS
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