Page 81 - DMGT207_MANAGEMENT_OF_FINANCES

Management of Finances

Notes W = Proportion of funds invested in Security B
B
R = Expected return of Security A
A
R = Expected return of Security B
B
W + W = 1
A B
Illustration 10: A Ltd.'s share gives a return of 20% and B Ltd.'s share gives 32% return. Mr.
Gotha invested 25% in A Ltd.'s shares and 75% of B Ltd.'s shares. What would be the expected
return of the portfolio?
Solution:
Portfolio Return = 0.25(20) + 0.75 (32) = 29%
Illustration 11: Mr. RKV's portfolio consists of six securities. The individual returns of each of
the security in the portfolio are given below:
Security Proportion of investment in the portfolio Return
Wipro 10% 18%
Latham 25% 12%
SBI 8% 22%
ITC 30% 15%
RNL 12% 6%
DLF 15% 8%

Calculate the weighted average of return of the securities consisting the portfolio.
Solution:

Security Weight (W) Return (%) (R) (W × R)
Wipro 0.10 18 1.80
Latham 0.25 12 3.00
SBI 0.08 22 1.76
ITC 0.30 15 4.50
RNL 0.12 6 0.72
DLF 0.15 8 1.20
12.98

 Portfolio return is 12.98%.

4.7.2 Risk of Portfolio (Two Assets)

The risk of a security is measured in terms of variance or standard deviation of its returns. The
portfolio risk is not simply a measure of its weighted average risk. The securities that a portfolio
contains are associated with each other. The portfolio risk also considers the covariance between
the returns of the investment. Covariance of two securities is a measure of their
co-movement; it expresses the degree to which the securities vary together. The standard
deviation of a two-share portfolio is calculated by applying formula given below:
2
2
2
2
 = W σ + W σ + 2W W ρ σ σ
p A A B B A B AB A B
Where,
 = Standard deviation of portfolio consisting securities A and B
p
W W = Proportion of funds invested in Security A and Security B
A B
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