Page 80 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Unit 2: Risk and Return

Notes

Case Study RKV’s Portfolio

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%

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 2
p = W σ + W σ + 2W W ρ σ σ B
B
B
A
A
A
AB
B
A
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
= Standard deviation of returns of Security A and Security B
A B
= Correlation coefficient between returns of Security A and
AB
Security B
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