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CHAPTER 6
AN INTRODUCTION TO PORTFOLIO MANAGEMENT
I. Some Background Assumptions
A. Risk Aversion – Given a choice between two assets with equal rates of return, most
II. Markowitz Portfolio Theory
Definition of an efficient asset or portfolio of assets
Under certain assumptions, a single asset or portfolio of assets is considered to be
B. Expected Return
For an individual asset – sum of the potential returns multiplied with the
corresponding probability of the returns (Exhibit 6.1)
D. Standard Deviation of Returns for a Portfolio
1. Covariance of Returns – a measure of the degree to which two variables move
together relative to their individual mean values over time (Exhibits 6.4, 6.5, 6.6, 6.7,
and 6.8)
2. Covariance and Correlation – The correlation coefficient is obtained by standardizing
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E. Standard Deviation of a Portfolio
1. Portfolio Standard Deviation Formula – the standard deviation for a portfolio of
assets is a function of the weighted average of the individual variances (where the
F. A Three-Asset Portfolio – It shows the dynamics when assets are added and the rapid
growth of the calculations required.
G. Estimation Issues
The accuracy of the input is important – beware of estimation risk.
III. The Efficient Frontier and Investor Utility (Exhibits 6.14, 6.15, 6.16)
The efficient frontier represents that set of portfolios that has the maximum rate of