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Measurement of Risk and Calculation of Portfolio Risk
Measurement of Risk and Calculation of Portfolio Risk
Made By:
Dharti Shah 46
Dhrumil Shah 47
Kavisha Shah 48
Param Shah 49
Shairavi Shah 50
Risk
1 20% 5% 50%
E[R]A = 12.5%
E[R]B = 20%
Given an asset's expected return, its variance can be
calculated using the following equation:
N
Var(R) = s2 = S pi(Ri – E[R])2
i=1
Where:
◦ N = the number of states
◦ pi = the probability of state i
◦ Ri = the return on the stock in state i
◦ E[R] = the expected return on the stock
The standard deviation is calculated as the positive
square root of the variance:
Where:
◦ E[Rp] = the expected return on the portfolio
◦ N = the number of stocks in the portfolio
◦ wi = the proportion of the portfolio invested in stock i
◦ E[Ri] = the expected return on stock i
For a portfolio consisting of two assets, the above
equation can be expressed as:
E[Rp] = w1E[R1] + w2E[R2]
Where:
◦ sA,B = the covariance between the returns on stocks A
and B
◦ N = the number of states
◦ pi = the probability of state i
◦ RAi = the return on stock A in state i
◦ E[RA] = the expected return on stock A
◦ RBi = the return on stock B in state i
◦ E[RB] = the expected return on stock B
The Correlation Coefficient between the returns on two
stocks can be calculated as follows:
sdA,B Cov(RA,RB)
Corr(RA,RB) = pA,B = sdAsdB = SD(RA)SD(RB)
Where:
◦ pA,B=the correlation coefficient between the returns on
stocks A and B
◦ sdA,B=the covariance between the returns on stocks A
and B,
◦ sdA=the standard deviation on stock A, and
◦ sdB=the standard deviation on stock B
The covariance between stock A and stock B is as
follows:
s2p=(.75)2(.0512)2+(.25)2(.2049)2+
2(.75)(.25)(1)(.0512)(.2049)= .00016
sp =√.00016=.0128=1.28%