INVESTMENTS Capital allocation between the risk asset and the iskfreeeisget
INVESTMENTS Capital allocation between the risky Capital allocation between the risky asset and the risk asset and the risk-free asset free asset Chapter 3 Chapter 3
INVESTMENTS The choice of proportion in safe asset and proportion in risky asset a Most institutional investors follows top- down analysis---The first part is asset allocation and the next part is security selection decision
INVESTMENTS Capital allocation Capital allocation The choice of proportion in safe asset and proportion in risky asset; Most institutional investors follows topdown analysis---The first part is asset allocation and the next part is security selection decision
INVESTMENTS Capital allocation across risky and risk- ree porrol1oS---excirrple Total wealth 300.000 a90,000 in money market The remaining is in risky assets---113 400 in ibm and 96. 600 in gm a The risky portfolio is 54%in IBM, and 46% in GM a The complete portfolio is 30% in risk-free asset; 70% in risky portfolio
INVESTMENTS Capital allocation across risky and risk Capital allocation across risky and risk- free portfolios free portfolios---example example Total wealth 300,000; 90,000 in money market; The remaining is in risky assets---113,400 in IBM and 96,600 in GM The risky portfolio is 54% in IBM, and 46% in GM; The complete portfolio is 30% in risk-free asset; 70% in risky portfolio
INVESTMENTS Portfolio of one risky asset and one risk a Weight in risky portfolio is y, in risk-free asset Is l-y a Return on the risky portfolio is Rp, return on risky free asset is Rr, Suppose E(Rn)=15%0n=22%,R=7% a Portfolio return is R=yR,+(1-y)R
INVESTMENTS Portfolio of one risky asset and one risk Portfolio of one risky asset and one risk- free asset free asset Weight in risky portfolio is y, in risk-free asset is 1-y; Return on the risky portfolio is Rp, return on risky free asset is Rf; Suppose Portfolio return is E(Rp ) =15%,σ p = 22%,Rf = 7% C p Rf R = yR + (1− y)
INVESTMENTS corrIne The expectation of the portfolio return is E(R)=yER, )+(1-yR R +ye(r-RI 7+y(15-7) Standard deviation of the portfolio return is c= yo,=22y ■ We can also write E(RC)=R+yLE(Rp)-R R+[E(R2)-R +—0
INVESTMENTS continued continued The expectation of the portfolio return is Standard deviation of the portfolio return is We can also write y y C p σ = σ = 22 ( ) ( ) 7 (15 7 ) [ ( ) ] ( 1 ) = + − = + − = + − y R y E R R E R yE R y R f p f C p f C p f p C f C f p f R E R R E R R y E R R σ σ σ 22 8 7 [ ( ) ] ( ) [ ( ) ] = + = + − = + −