Portfolio Management

Risk is less than weighted average of risk

Portfolio Risk

Riskiness of individual shares

Relationship between their returns

Correlation

High correlation = risk is close to weighting

Correlation = 0 = no risk

Variability of portfolio returns is similar to individual shares

Less likely to result in a reduction of risk

Variance of Portfolio

(Weighting^2 Variance) + (Weighting^2 Variance) + 2(Weighting)(Weighting) * Covariance

Covariance

(Correlation of portfolio)(standard deviation)(standard deviation)

Required return on a share

Risk-free rate + Beta(Expected market return - Risk-free rate)

Capital Asset Pricing Model

Beta

Reflects sensitivity of individual share to fluctuations in market

Risk is less than weighted average of risk

Correlation co-efficient of portfolio

Stand. Dev of portfolio / Stand. Dev. o* Stand. Dev

Company financed by only equity will have a project beta = equity beta

Measures shares non-diversifiable risk (systematic risk)

Market Beta = 1