Discussion of Portfolio Theory Coursework Example | Topics and Well Written Essays - 750 words - 1

Discussion of Portfolio Theory - Coursework Example Corporate investors use the same concept when they build up a portfolio. The above discussion demonstrates that asset is a weight in the portfolio. An investor never buys all securities of the financial market; rather selects a combination of securities. This is when the concept of risk arises. Thus, portfolio theory has two important parameters: weight of an asset in the portfolio and its risk. The concept risk relates to the return on investment. Let us consider a single stock A. The stock A has predicted returns for different economic states as well as the probability of occurring these states. Theoretically three states are considered: boom, average, and recession. Using formulas, one can calculate expected return, E (rA), and risk of the return of the stock A. The risk of return is expressed through standard deviation ÏÆ', and in percentage. A portfolio consists of multiple financial instruments, each of them with specific predicted returns. Let us now say, we have three securi ties in a portfolio: stock B, stock C, and stock D. The portfolio return will be E (r portfolio) = WB x E (rB) + WC x E (rC) + WD x E (rD). The value of E (r Portfolio) will compensate the risk of each single security.A portfolio consists of Gold Stock, Auto Stock with relative weight 75 % and 25 %. The return is shown below.: Convert predicted returns of two stocks to the return of one average stock. The formula is Average predicted return = Weight of Auto stock x Predicted return + Weight of Gold stock x Predicted return.