Portfolio Theory & The Benefits of Diversification

Chapter: 12 Portfolio Theory & The Benefits of Diversification

Section: 4 Expected Return for a Portfolio Containing a Risk-Free Asset

Lets take a portfolio that is invested 70% in S&P 500 Index Mutual Fund and 30% in Treasury Bills. The expected return on the fund is 12% and the standard deviation is 25%. The return on T-Bills is 4% and the expected standard deviation is zero. The correlation between the two assets is also zero.

            

E(Rp)

=

  0.7(12%) + 0.3(4%) = 9.6%
         

σp  

=

  0.7(25%)  = 17.5%

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