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Investments: Principles of Portfolio and Equity Analysis by Gerhard Van de Venter, CFA, Wendy L. Pirie, CFA, Jerald E. Pinto, CFA, Michael G. McMillan, CFA

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CHAPTER 5

PORTFOLIO RISK AND RETURN: PART I

Vijay Singal, CFA

Blacksburg, VA, U.S.A.

LEARNING OUTCOMES

After completing this chapter, you will be able to do the following:

  • Calculate and interpret major return measures and describe their applicability.
  • Describe the characteristics of the major asset classes that investors would consider in forming portfolios according to mean–variance portfolio theory.
  • Calculate and interpret the mean, variance, and covariance (or correlation) of asset returns based on historical data.
  • Explain risk aversion and its implications for portfolio selection.
  • Calculate and interpret portfolio standard deviation.
  • Describe the effect on a portfolio’s risk of investing in assets that are less than perfectly correlated.
  • Describe and interpret the minimum-variance and efficient frontiers of risky assets and the global minimum-variance portfolio.
  • Discuss the selection of an optimal portfolio, given an investor’s utility (or risk aversion) and the capital allocation line.

1. INTRODUCTION

Construction of an optimal portfolio is an important objective for an investor. In this chapter, we will explore the process of examining the risk and return characteristics of individual assets, creating all possible portfolios, selecting the most efficient portfolios, and ultimately choosing the optimal portfolio tailored to the individual in question.

During the process of constructing the optimal portfolio, several factors and investment characteristics are considered. ...

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