Consider Securities D and E with the following estimates: E(RD) = 8% σD= 12% E(RE) = 13% σE = 20% Now consider the portfolios that can be formed with D and E, assuming that the investment is equal between D and E (that is, each has a weight of 50%). What is the portfolio’s standard deviation if the correlation between D and E for each of the following? (a) ρD ; (b) ; (c) ; (d) E = 1 ρDE = 0.3 ρDE = 0 ρDE = − 1
Continuous Probability Distributions
Probability distributions are of two types, which are continuous probability distributions and discrete probability distributions. A continuous probability distribution contains an infinite number of values. For example, if time is infinite: you could count from 0 to a trillion seconds, billion seconds, so on indefinitely. A discrete probability distribution consists of only a countable set of possible values.
Normal Distribution
Suppose we had to design a bathroom weighing scale, how would we decide what should be the range of the weighing machine? Would we take the highest recorded human weight in history and use that as the upper limit for our weighing scale? This may not be a great idea as the sensitivity of the scale would get reduced if the range is too large. At the same time, if we keep the upper limit too low, it may not be usable for a large percentage of the population!
Consider Securities D and E with the following estimates:
E(RD) = 8% σD= 12% E(RE) = 13% σE = 20%
Now consider the portfolios that can be formed with D and E,
assuming that the investment is equal between D and E (that
is, each has a weight of 50%). What is the portfolio’s standard
deviation if the
following? (a) ρD ; (b) ; (c) ; (d) E = 1 ρDE = 0.3 ρDE = 0
ρDE = − 1
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