MBA 19-21

IMD / OPTS501
Suresh Venkatraman
Pre Reading for class of 14th August

Sunday, August 11, 2019 Portfolio Returns 1 of 10

 Portfolio Returns MBA 19-21
IMD / OPTS501
Suresh Venkatraman

◼ Investment opportunities often use both:

❑ Expected return as a measure of reward.

Pre Reading for class of 14th August

❑ Variance or standard deviation of return as a measure of risk.

◼ Portfolio is defined as a collection of assets such as stocks and bonds.

❑ Let X and Y represent two random variables, denoting, say, the

returns of two assets.

❑ Since an investor may have invested in both assets, we would like

to evaluate the portfolio return formed by a linear combination of
X and Y.

Sunday, August 11, 2019 Portfolio Returns 2 of 10

 Portfolio Returns MBA 19-21
IMD / OPTS501
Suresh Venkatraman

◼ Properties of random variables useful in evaluating portfolio

returns.
Pre Reading for class of 14th August

❑ Given two random variables X and Y,

◼ The expected value of X + Y is
E ( X + Y ) = E ( X ) + E (Y )
◼ The variance of X + Y is
Var ( X + Y ) = Var ( X ) + Var (Y ) + 2Cov ( X ,Y )
where Cov(X,Y) is the covariance between X and Y.

Sunday, August 11, 2019 Portfolio Returns 3 of 10

 Portfolio Returns MBA 19-21
IMD / OPTS501
Suresh Venkatraman

◼ Properties of random variables useful in evaluating portfolio

returns.
Pre Reading for class of 14th August

❑ Given two random variables X and Y, and the constants a, and b

◼ The expected value of aX + bY is

E ( aX + bY ) = aE ( X ) + bE (Y )

◼ The variance of aX + bY is

Var ( aX + bY ) = a2Var ( X ) + b2Var (Y ) + 2abCov ( X ,Y )

where Cov(X,Y) is the covariance between X and Y

Sunday, August 11, 2019 Portfolio Returns 4 of 10
 Portfolio weights MBA 19-21
IMD / OPTS501
Suresh Venkatraman

❑ Given a portfolio with two assets, Asset A and Asset B,

❑ the expected return of the portfolio E(Rp) is computed as:

Pre Reading for class of 14th August

E ( Rp ) = w AE ( RA ) + w B E ( RB )

◼ wA and wB are the portfolio weights

◼ such that wA + wB = 1

◼ E(RA) and E(RB) are the expected returns on assets A and B,

respectively.

Sunday, August 11, 2019 Portfolio Returns 5 of 10

 Portfolio weights MBA 19-21
IMD / OPTS501
Suresh Venkatraman

❑ Using the covariance or the correlation coefficient of the two

returns, the portfolio variance of return is:
Pre Reading for class of 14th August

Var ( Rp ) = w A 2s A 2 + w B 2s B 2 + 2w Aw B r ABs As B
❑ where s2A and s2B are the variances of the returns for Asset A and
Asset B, respectively,

❑ rAB is the correlation coefficient between the returns for Asset A

and Asset B.

❑ the term rAB σA σB is the covariance between the returns for

Asset A and Asset B
Sunday, August 11, 2019 Portfolio Returns 6 of 10
 Stock market problem MBA 19-21
IMD / OPTS501
Suresh Venkatraman

◼ Example: Consider an investment portfolio of $40,000 in

Stock A and $60,000 in Stock B.
Pre Reading for class of 14th August

❑ Given the following information, calculate the expected

return of this portfolio.

Sunday, August 11, 2019 Portfolio Returns 7 of 10

 Solution to Stock market MBA 19-21
IMD / OPTS501

problem Suresh Venkatraman

Pre Reading for class of 14th August

Sunday, August 11, 2019 Portfolio Returns 8 of 10

 Solution to Stock market MBA 19-21
IMD / OPTS501

problem Suresh Venkatraman

◼ Consider an investment portfolio of $40,000 in Stock A and $60,000 in

Stock B.
Pre Reading for class of 14th August

Calculate the portfolio variance.

❑ Solution:

Sunday, August 11, 2019 Portfolio Returns 9 of 10

 Solution to Stock market MBA 19-21
IMD / OPTS501

problem Suresh Venkatraman

◼ Example: Consider an investment portfolio of $40,000 in

Stock A and $60,000 in Stock B.
Pre Reading for class of 14th August

❑ Calculate the portfolio standard deviation.

❑ Solution:

Sunday, August 11, 2019 Portfolio Returns 10 of 10