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3
µ =∑pn x n
CGI
n =1
=0.30(10%)+0.50(14%)+0.20( 20%)
=14.00%
n=1
=12.00
σ x = σ = 12.00 =3.46%
2
x
The Covariance
CD
n=1
=0.30(10−14)( 40−24)+0.50(14−14)(16−24)
+0.20( 20−14)( 20−24)
=− 24.00
The Correlation Coefficient
σxy
ρxy =
σ x σy
− 24.00
=
(3.46 )(10.58 )
=−0.655
Summary of Results for CGI and DSC
CGI DSC
Mean 14.00% 24.00%
Standard Deviation 3.46% 10.58%
The Expected
The The Risk The The
Returns
Portfolio of the Portfolio Correlation
of the
Weights Securities Weights Coefficients
Securities
Portfolio Weights and Expected
Return
Portfolio Weights Portfolio’s
CGI DSC Expected Standard
Return Deviation
1.00 0.00 14.00% 3.46%
0.75 0.25 16.50% 2.18%
0.67 0.33 17.33% 2.64%
0.50 0.50 19.00% 4.36%
0.25 0.75 21.50% 7.40%
0.00 1.00 24.00% 10.58%
Portfolio Expected Return and Risk
Home
25%
DSC
Expected Return
20%
15%
CGI
10%
0% 5% 10%
Standard Deviation
Diversification of Risk
25% Y
Expected Return
Correlation
Coefficient
15% -1.0
-0.5
0.0
X +0.5
+1.0
5%
0% 5% 10% 15% 20% 25% 30% 35%
Standard Deviation
Portfolios with Many Assets
F
µ (expected return)
σ (risk)
Choosing the Best Risky Asset
F
µ (expected return)
rf
σ (risk)
Best Risky Asset
F
µ (expected return)
rf
σ (risk)
The Capital Market Line
µm − rf
µp =rf + σ p
σm
The Capital Market Line
F
µ (expected return)
E
rf
σ (risk)
Next Coverage
σσ
(risk)
(risk)
The Capital Asset Pricing Model (CAPM)
µ j =r f +β j µ −r ( m f
)
•where
COV ( r , r ) ρ σ σ ρ σ
j M j, m j m j, m j
β = = =
j
σ2 σ2 σ
m
m m
What does the SML tell us
β p = w1 β 1 + w 2 β 2 + w 3 β 3 + + w n β n
•Capital Budgeting
⇒Investment Decision
⇒Determination of Cost of Capital
⇒Determination of Cash Flows