Sure, let's break down the calculation of portfolio variance and standard deviation using
mathematical symbols.
First, let's define the variables:
- Weights (proportion of investment) of securities A, B, and C: \(w_A = 0.2\), \(w_B = 0.3\),
\(w_C = 0.5\)
- Returns of securities A, B, and C: \(r_A = 0.41\), \(r_B = 0.17\), \(r_C = 0.52\)
- Standard deviations of securities A, B, and C: \(\sigma_A = 0.11\), \(\sigma_B = 0.09\),
\(\sigma_C = 0.15\)
- Correlation coefficients: \(\rho_{AB} = 0.8\), \(\rho_{AC} = 0.2\), \(\rho_{BC} = 0.5\)
The formula for the variance of a three-asset portfolio is:
\[
Var(P) = w_A^2 \cdot Var(A) + w_B^2 \cdot Var(B) + w_C^2 \cdot Var(C) + 2 \cdot w_A \cdot
w_B \cdot Cov(A,B) + 2 \cdot w_A \cdot w_C \cdot Cov(A,C) + 2 \cdot w_B \cdot w_C \cdot
Cov(B,C)
\]
Where \(Var(A)\), \(Var(B)\), and \(Var(C)\) are the variances of the returns of securities A, B,
and C, and \(Cov(A,B)\), \(Cov(A,C)\), and \(Cov(B,C)\) are the covariances between the
returns of the securities.
The variance of an asset is simply the square of its standard deviation, and the covariance
between two assets can be calculated as \(Cov(A,B) = \rho_{AB} \cdot \sigma_A \cdot
\sigma_B\), where \(\rho_{AB}\) is the correlation coefficient between the returns of A and B.
Substituting the given values into the formula, we get:
\[
Var(P) = (0.2)^2 \cdot (0.11)^2 + (0.3)^2 \cdot (0.09)^2 + (0.5)^2 \cdot (0.15)^2 + 2 \cdot 0.2
\cdot 0.3 \cdot 0.8 \cdot 0.11 \cdot 0.09 + 2 \cdot 0.2 \cdot 0.5 \cdot 0.2 \cdot 0.11 \cdot 0.15
+ 2 \cdot 0.3 \cdot 0.5 \cdot 0.5 \cdot 0.09 \cdot 0.15
\]
Solving this gives us the portfolio variance \(Var(P) \approx 0.01047\).
The standard deviation of the portfolio, also known as the portfolio risk or volatility, is the
square root of the portfolio variance. So, \(StdDev(P) = \sqrt{Var(P)} \approx \sqrt{0.01047}
\approx 0.10234\).
So, the portfolio variance is approximately 0.01047 and the standard deviation is
approximately 0.10234 (or 10.234% when expressed as a percentage).