RISK

AND
RETURN

8.3 Risk of a Portfolio

In real-world situations, the risk of any
single investment would not be viewed
independently of other assets. New
investments must be considered in light of
their impact on the risk and return of an
investors portfolio of assets. The financial
managers goal is to create an efficient
portfolio, one that provides the maximum
return for a given level of risk.

Expected Portfolio Returns

The expected return on a portfolio, is the
weighted average of the expected returns of
the individual assets in the portfolio, with the
weight being the percentage of the total
portfolio invested in each asset:

* INSERT
FORMULA*

Portfolio Risk

Although the expected return on a

portfolio is simply the weighted average of
the expected returns on its individual
stocks, the portfolios risk, is not the
weighted average of the individual stocks
standard deviations. The portfolios risk is
generally smaller than the average of the
stocks because diversification lowers the
portfolios risk.