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Markowitz Portfolio Theory II

Markowitz Portfolio Theory II


Expected Return:
This is the return that an investor expects an
investment to earn over the next period.
The actual return may be either higher or lower
It may be simply the average return per period
a security has earned in the past .
It may be based on a detailed analysis of a
firms future prospects.
It may be based on special information.
Expected Return, Variance & Standard
Deviation
Expected Return (ERA) of Supertech Limited:
State of Economy % Return
Depression -20
Recession 10
Normal 30
Boom 50
Expected Return (ERA)= -0.20 + 0.10 + 0.30 + 0.50
4
= 0.70 /4 = 0.1750 = 17.50%

Expected Return, Variance & Standard
Deviation
Deviation from Expected Return:(ER= 17.50% or 0.1750)
State of Economy Rate of Return Deviation from ER
(Ri ER)
Depression -0.20 -0.20 0.175 = -0.375
Recession 0.10 0.10 0.175 = -0.075
Normal 0.30 0.30 0.175 = 0.125
Boom 0.50 0.50 0.175 = 0.325
Expected Return, Variance & Standard
Deviation
Deviation from Expected Return:(ER= 17.50% or 0.1750)
State of Economy Rate of Return Deviation from ER Squared Value of Deviation
(Ri ER) (Ri ER)
Depression -0.20 -0.20 0.175 = -0.375 (-0.375) = 0.140625
Recession 0.10 0.10 0.175 = -0.075 (-0.075) = 0.005625
Normal 0.30 0.30 0.175 = 0.125 (0.125) = 0.015625
Boom 0.50 0.50 0.175 = 0.325 (0.325) = 0.105625
0. 267500



Variance [ Var (RA)] = = 0.267500 =0.066875
4
Variance of a security measures variability of an individual
securitys return
Standard Deviation [SD (RA)] = = 0.066875 = 0.2586

= 25.86%














Expected Return, Variance & Standard
Deviation
Expected Return of Slowpoke Limited.

State of Economy Slowpoke Rate of Return (%)
Depression 5
Recession 20
Normal -12
Boom 9
Expected Return (ER) = 0.05+0.20-0.12+0.09 = 0.22 = 0.055
4 4
= 5.5%
Expected Return, Variance & Standard
Deviation
Expected Return of Slowpoke Limited.

State of Economy Rate of Return (%) Deviation (Ri ER) Squared Value of Deviation
(Ri ER)
Depression 5 0.05 0.055 = -.005 (-.005) = 0.000025
Recession 20 0.20 0.055 = 0.145 (0.145) = 0.021025
Normal -12 -0.12 0.055 = -0.175 (-0.175) = 0.030625
Boom 9 0.09 0.055 = 0.035 (0.035) = 0.001225
0.052900
ER = 0.05+0.20-0.12+.09 = 0.055 = 5.5% ; = 0.052900 = 0.013225; = 0.013225 = 0.115000 = 11.5%
4 4
Expected Return, Variance & Standard
Deviation
Covariance = (RA ERA ) X (RB ERB )
It is interrelation between the two securities.

Correlation coefficient = Covariance A, B
(A ) ( B )
It is a relative measure of a given relationship