Summary to Date
• Investing is about measuring and understanding
the risk/return relationship
• Risk
– Measured through the use of standard deviation
– Controlled through diversification
• The Capital Allocation Line
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The Sharpe Ratio (reward to volatility)
The mean-variance criterion
The optimal risky portfolio
The minimum variance portfolio
Intermediate Investments F303
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Summary to Date
• While the return of a portfolio made up of two
assets is simply the weighted average, the standard
deviation is only a weighted average if the assets
are perfectly correlated
• Otherwise, the standard deviation is something
less than the weighted average, showing the
benefits of diversification!
Intermediate Investments F303
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The Optimal Risky Portfolio
• Optimal Risky Portfolio (p. 200 has an error)
WA = (RPA) * (VARZ) – (RPZ)(SDA)(SDB)(RhoAZ)
--------------------------------------------------------------------------(RPA)*(VARZ) + (RPZ)*(VARA) -(RPA+RPZ)(SDA)(SDZ)(RhoAZ)
Intermediate Investments F303
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The Minimum Variance Portfolio
• Minimum Variance Portfolio (p. 197)
WA = (VARZ) – (SDA)(SDZ)(RhoAZ)
-----------------------------------------------------(VARZ) + (VARA) – 2(SDA)(SDZ)(RhoAZ)
Intermediate Investments F303
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