Required: 1. What is the volatility of the portfolio as the number of stocks becomes arbitrarily large? 2.What is the average correlation of each stock with this large portfolio?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Consider an equally weighed portfolio of stocks in which each stock has a volatility of 40%, and the correlation between each pair of stocks is 27%.
Required:
1. What is the volatility of the portfolio as the number of stocks becomes arbitrarily large?
2.What is the average correlation of each stock with this large portfolio?
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