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Risk and Return: Portfolio【Deric Business Class】 - YouTube
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hey guys welcome to derek business class
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in this video I'm gonna talk about the
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risk and return for portfolio an
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investment portfolio is any collection
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or combination of financial assets when
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you bought three company shares these
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companies shares or your portfolio if we
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assume all investors are rational and
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therefore is diverse then investors will
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always choose to invest in portfolios
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rather than in single assets investors
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will hold portfolios because he or she
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will diversify away a portion of the
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risk that is inherent in putting all
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your eggs in one basket remember don't
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put all your eggs in one basket
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if an investor holds a single asset he
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or she will fully suffer the
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consequences of poor performance the
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goal is to form a well diversified
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portfolio of assets so that the risk
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will become lower to calculate the
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portfolio return we take the weighted
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average of the returns on the individual
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assets from which it is formed based on
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this formula portfolio return can be
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calculated by taking the summation of
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weight of the asset times return of the
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asset to calculate the portfolio
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standard deviation we apply this formula
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let's take an example suppose you have
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$15,000 to invest and you have purchased
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securities in the following amounts
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what are your portfolio weights in each
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security $2,000 of a $3,000 of be $4,000
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of C and $6,000 of D to get the weight
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of a you just need to take $2,000 over
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$15,000 then you will get 0.133 do the
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same for B C and D then you will get
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zero point two zero point two six seven
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and zero point four consider the
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portfolio weights computed previously if
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the individual stocks have the following
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expected returns what is the expected
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return for the portfolio a nineteen
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point six nine percent B 5.25% C sixteen
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point six five percent D eighteen point
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two four percent by taking the weights
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multiplied with the returns you will get
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the portfolio return fifteen point four
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one percent let's try the next question
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consider the following information where
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you invest 50 percent in asset a another
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50% in asset B and the returns for each
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state of economy are estimated boom
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means good time whilst bust means bad
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time calculate the return and standard
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deviation for each asset then for the
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portfolio first get the expected return
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and standard deviation for each asset
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for asset a by taking zero point four
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times 30% plus zero point six times
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negative ten percent you will get 6%
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then take 30% minus six percent square
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it times a zero point four plus negative
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ten percent minus six percent square it
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times zero point six you will get the
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variance for asset a380 for then open
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square root for the variance you will
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get the standard deviation for asset a
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nineteen point six percent
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at be follow the same way then you will
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get returned 13% and standard deviation
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14.7% next get the expected return and
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standard deviation for the portfolio
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first step is to calculate the portfolio
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return and boomed by taking 0.5 times
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30% plus 0.5 times negative 5 you will
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get 12.5% then calculate the portfolio
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return and bust taking 0.5 times
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negative 10% plus 0.5 times 25% you will
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get 7.5% expected portfolio return can
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be calculated by taking 0.4 times 12.5%
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plus 0.6 times 7.5 percent you will get
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9.5 percent before calculating the
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standard deviation you need to get the
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variance first by taking 0.4 times 12.5%
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minus nine point five percent square it
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plus 0.6 times 7.5 percent minus nine
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point five percent square it then you
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will get the variance of portfolio open
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square root of the variance you will get
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standard deviation of portfolio equals
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two point four five percent one thing
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that you may take note portfolio return
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lies between return of asset a and asset
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B but portfolio risk is very much lower
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than the risk of asset a an asset B
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that's the reason of forming a portfolio
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do you remember portfolio can diversify
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the risk which means it can reduce the
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risk
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another method of calculating portfolio
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risk is by using this formula first you
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need to calculate the covariance after
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this the next step is to calculate the
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variance of portfolio then you can get
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the standard deviation as shown here
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combining two investments can reduce the
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portfolio risk however it has to happen
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under certain conditions diversification
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is enhanced depending upon the extent to
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which the returns on assets move
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together this movement is typically
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measured by a statistic known as
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correlation as shown in the figure below
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if two investments are moving together
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going up and down together they are
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positively correlated but if one going
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up while the other one going down they
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are negatively correlated only when two
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investments are negatively correlated
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will reduce the overall risk generally
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investing in more than one security can
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reduce risk but if two stocks are
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perfectly positively correlated
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diversification has no effect on risk
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which means the risk cannot be reduced
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however if two stocks are perfectly
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negatively correlated the portfolio is
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perfectly diversified which means the
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risk can be reduced drastically but in
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reality it is quite impossible to find
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two investments that are perfectly
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negatively correlated so the rationale
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of forming portfolios to choose assets
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with negative or low positive
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correlation to realize diversification
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benefits even if two assets are not
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perfectly negatively correlated an
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investor can still realize
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diversification benefits from combining
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them in a portfolio as shown in the
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figure the risk after combining two
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assets becomes lower so if you owned a
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share of 1000 companies traded on the
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stock exchange would you risk be
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diversified the answer is surely yes but
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would you have eliminated all your
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portfolio risk the answer is no common
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stock portfolio still has risk
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are two types of risk in a portfolio
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first is systemic risk or market risk
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this is the risk that affects all firms
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such as tax rate changes and war ii is
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on systemic risk or company unique risk
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this is the risk that affects only a
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specific firm such as labor strikes and
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CEO change out of these two types of
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risk only unsystematic risk can be
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reduced or eliminated through effective
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diversification market risk is also
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called systemic risk or non
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diversifiable risk this type of risk
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cannot be diversified away for examples
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unexpected changes in interest rates
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inflation rates tax rate foreign
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competition and the overall business
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cycle that's why it is also known as
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relevant risk we use bata to measure the
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market risk
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however company unique risk is also
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called unsystematic risk or diversify
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Abul risk this type of risk can be
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reduced through diversification for
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examples companies labor force goes on
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strike companies top management dies in
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a plane crash huge oil tank bursts and
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floods a company's production area so if
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you invest in 10 companies when one
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company has got some problems it may not
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affect your portfolio very much this is
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what we called diversification generally
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if you combine more different companies
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shares into your portfolio your
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diversify above risk will be reduced if
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you have 25 to 30 company shares your
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diversify above risk will be reduced to
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the minimal but for the portion of non
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diversify double risk it is always
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constant and cannot be reduced no matter
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how many company shares you combine into
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your portfolio diversify above risk plus
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non diversify Abul risk you will get the
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total risk standard deviation basically
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is a measure of total risk
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if you hold a portfolio of domestic
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assets only your risk is still higher
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but if you can hold a portfolio of both
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domestic and international assets your
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risk will become lower because assets or
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investments from different countries may
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not move together when they don't move
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together risk will be reduced as a
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summary as we know the market
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compensates investors for accepting risk
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but only for market risk company unique
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risks can and should be diversified away
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market risk cannot be eliminated through
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diversification
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because that variability is caused by
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events that affect most stocks similarly
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the standard deviation of returns is a
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measure of total risk beta is a measure
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of market risk or systemic risk
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all right that's all for this video
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thanks for watching see you in the next
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one bye
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