Risk and

Return
Portfolio Risk
 Objective is to minimize the risk for a given
return OR maximize the return for a given
level of risk
Portfolio Return
 Thereturn on a portfolio is a weighted
average of the returns on the individual
assets from which it is formed.

 Rp= (w1 * R1) + (w2 * R2) +…+ (wn * Rn)

𝑛

𝑅𝑝 = ෍ 𝑤𝑗 ∗ 𝑅𝑗
𝑗=1
Q.1 Portfolio Return
State of Boom Moderate Recession
Economy
Probability 0.25 0.50 0.25
Share Return (%)
A 20 18 15
B 30 24 20
C 25 12 -6
D 12 24 30
E 40 30 20

Find the portfolio return of the above portfolio is these five

shares are in the ratio of 1:2:3:4:5.
Q.2_ Portfolio Return
 Shares of the five firm denoted as 1 to 5 are
projected to have returns of 15%, 20%, 12%,
25% and 30% respectively. Based on the this
information answer the following questions:-
 If the portfolio consists of all the five shares
in equal proportions what is the expected
return?
 What is the return of the portfolio if 40% of
the funds are put in the security of firm 5
yielding a return of 30% and the remainder
is divided equally in the remaining four
securities.
Portfolio Risk
 The risk of a portfolio is measured by either
variance or standard deviation of its
returns.
 Variance is the average of squared
differences from the mean.

𝑉𝑎𝑟, 𝞼2𝑝 = ෍ 𝑋𝑝 − 𝑋𝑝 2𝑝𝑗

𝑗=1
Covariance
 It tell the us as to how much any pair of asset move
around together
 It is an important insight for construction of an
efficient portfolio
 It uses historical data to establish relationship
 Covariance helps us to know if there are any
common variables which affect the return
 It is the product of 2 variables deviation from their
average values which is divided by number of
observations
 𝐶𝑜𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = ∑[ p (X-X) (Y-Y)]
Covariance
 Portfolio variance is determined by
covariance of the securities.
 Covariance is a measure of how returns
co-vary with each other
 A positive covariance means that the
direction of change in the return of the
two securities is same, while a negative
covariance implies the changes are in
opposite direction
 Question 3. for Covariance
State of economy probability X Y
A 0.1 15 17
B 0.2 12 8
C 0.4 -7 -3
D 0.2 3 13
E 0.1 -4 25
Coefficient of Correlation:
An aid for diversification
Coefficient of correlation
A relative measure of the relationship of
returns of two securities.
 Larger the coefficient, greater is the
correlation between the two securities
 It tells us as to what proportion of two
assets price movements are determined
by same market forces
Coefficient of correlation
 Positive correlation signifies same
behavior while negative correlation
implies opposite behavior of returns of the
two securities
 To reduce the overall risk, it is best to
diversify by combining or adding the
portfolio assets that have a negative or
low positive correlation
𝐶𝑜𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒
 r=
𝜎𝑥 𝜎 𝑦
Portfolio Risk
 𝜎𝑝 = √𝑤12𝞼12+𝑤22𝞼22+ 2 𝑤1𝑤2r1,2 𝞼1𝞼2
 Question for Portfolio risk_Q4
State of economy probability Yes Bank Tata Motors
A 0.1 15 17
B 0.2 12 8
C 0.4 -7 -3
D 0.2 3 13
E 0.1 -4 25

Assume both the assets are being used in equal proportion,

what is the portfolio SD.
 Question 5
State of Economy P ONGC Sun Pharma
Very good 0.10 22% 25%
Good 0.15 20% 18%
Average 0.55 19% 17%
Bad 0.15 12% -1%
Very Bad 0.05 -4% -8%

Mr Chen wants to invest in these assets in equal proportion. You

are required to calculate portfolio return and portfolio risk for Mr.
Chen.