Portfolio of Two Securities

? The expected return of the portfolio is the weighted average of the component returns

rP?wr1??1?w?r2

? The volatility of the portfolio is not quite simple

?P?w?1??1?w??2 (wrong!)

22222?P?w?1?2w?1?w??12?1?2??1?w??2

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Portfolio with the Riskless Asset and a Single Risky Asset

? Riskless asset: future return is certain

? Assume a world with a single risky asset and the riskless asset

? The risky asset is, in the real world, a portfolio of risky assets

? Assume that you invest w proportion of your wealth in the risky asset (portfolio) 1; 1-w invested in the riskless asset 2

? Risky asset: r1?14% and ?1?20%

? Riskless asset: r2?6% and ?2?0

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Portfolio with the Riskless Asset and a Single Risky Asset

? Portfolio return and standard deviation

rP?wr1??1?w?r2

??w??2w?1?w??12?1?2??1?w??2P222121222?w? ?P?w?1

? If w?0.25 then rP?8% and ?P?5%

If w?0.75 then rP?12% and ?P?15%

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Portfolio of a Risky and a Riskless Security0.25Expected Return0.20.150.10.05000.10.2Standard Deviation0.30.4 20