Okay, so continuing with the continuous compounded returns. Now, we want to look at portfolio returns.

So remember when you have simple returns, a portfolio is just a collection of assets and, portfolios are defined by how much of your wealth do you have invested in each asset. And so these little XIs are, are portfolio shares, so these are fractions of wealth. And we derived the result that the rate of return on the portfolio is a weighted average of the rates of return on the individual securities and the portfolio. Okay? So that's the portfolio rate of return. What is the def, what is the continuously compounded portfolio rate of return? Well, just like all other continuously compounded returns, the continuously compounded portfolio return is the logarithm of one + the simple return. So it's one + the simple return on the portfolio. The simple return on the portfolio is this weighted average. So the continuously compounded return is the logarithm of one + the sum. Now, the log rhythm one + the sum is not equal to the sum of the continuously compounded returns. So you have this result when you work with continuous compounding, that the continuously compounded portfolio return is not a weighted average of the continuously compounded returns of each of the securities. That's not an exact result. So portfolio returns are not additive in the continuously compounded space. But if the portfolio return is not too big then we know that the portfolio return is approximately equal to the simple return and so it's approximately additive if the return is not too big. So again, we can do an example, just to illustrate the differences here and to, to show that the differences are not too large. So again a portfolio of Microsoft and Starbucks we put 25% of our wealth in Microsoft, 75% in Starbucks. The simple return on Microsoft over the month is 5.88%. The simple return on Starbucks is -5.03%. And so the simple return on the portfolio, the weighted average of the returns on the two securities, is now 3.56%. Alright? T he continuously compounded portfolio return is the logarithm of one + the simple return. And so that's a logarithm of 1- this because our, our simple return is negative. So that's the logarithm of .96. And so that's -.0359. So notice that the continuously compounded portfolio return is a smaller

negative number than the simple portfolio return. Now, what about the weighted average of the continuously compounded returns? The continuously compounded return on Microsoft is 5.72. The continuously compounded return on Starbucks is .069 and so when you calculate a weighted average of the continuously compounded returns, you get -3.75. Notice that it's not equal to this. And so, we don't have this, this nice result that the portfolio return has added to it, but it's pretty close. So this portfolio return is, you know it's not too far away. So the, you know pretending that the relationship is add, additive is not too much of an error. Alright. Another reason for working with continuously compounded returns is that things like adjusting for inflation become a little bit easier as well. So for example, we can define the continuously compounded real return as one plus the simple real return. And remember, one plus the simple real return is the ratio of prices times the inverse ratio of the consumer price index. So the continuously compounded real return is one + this, so it's the logarithm of this ratio and remember the logarithm of the product is equal to the sum of the logarithms. The logarithm of the ratio prices is the continuously competitive return on the security. The logarithm of this inverse ratio of the CPI is minus the continuously compounded inflation rate. So when we work with continuous compounding, the real continuously compounded rate of return is the nominal continuously compounded rate of return minus the continuously compounded inflation rate. So we get this exact relationship that real is equal to nominal minus inflation when we have continuous compounding. So again, that's a simple result and the k ey thi ng is that we, now we're defining inflation to be the log difference in the consumer price index. So again we can do this example. The nominal rate of return is 5.8, the inflation rate is one%. The real rate of return is 4.83. It continues dependent real rate of return, is logarithm one + the real rate, 4.1% or we can compute this real rate as the nominal continues dependent return minus nominal inflation, it gives us the same answer.