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W1 = Proportion of funds in Security 1
W2 = Proportion of funds in Security 2
r1 = return on Security 1
r2 = return on Security 2
E(): expected return
rp = W1r1 + W2r2

E(rp) = W1E(r1 ) + W2E(r2 )


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p2 = w1212 + w2222 + 2W1W2 Cov(r1r2)

12 = Variance of Security 1


22 = Variance of Security 2
Cov(r1r2) = Covariance of returns for
Security 1 and Security 2
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Cov(r1r2) = Œw 12
Œ1,2 = Correlation coefficient of
returns
1 = Standard deviation of returns for
Security 1
2 = Standard deviation of returns for
Security 2
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4 

ange of values for Œ1,2


+ 1.0 > Π> -1.0
If Œ= 1.0, the securities would be perfectly
positively correlated
If Œ= - 1.0, the securities would be
perfectly negatively correlated
If Π then the variance is reduced
    
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rp = W1r1 + W2r2 + W3r3
E(rp) = W1E(r1) + W2E(r2) + W3E(r3 )

2 p= W1212 + W2212 + W3232

+ 2W1W2 Cov(r1r2)
+ 2W1W3 Cov(r1r3)
+ 2W2W3 Cov(r2r3)
      
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(ri - rf) = Ô i + ßi(rm - rf) + ei
isk Prem Market isk Prem
or Index isk Prem
ҏÔ = the stock¶s expected return if the
i
market¶s excess return is zero (rm - rf) = 0
ßi(rm - rf) = the component of return due to
movements in the market index
ei = firm specific component, not due to market
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m = (rm - rf) format

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