Lessons
- CFA Level 2: Portfolio Management – Introduction
- Mean-Variance Analysis Assumptions
- Expected Return and Variance for a Two Asset Portfolio
- The Minimum Variance Frontier & Efficient Frontier
- Diversification Benefits
- The Capital Allocation Line – Introducing the Risk-free Asset
- The Capital Market Line
- CAPM & the SML
- Adding an Asset to a Portfolio – Improving the Minimum Variance Frontier
- The Market Model for a Security’s Returns
- Adjusted and Unadjusted Beta
- Multifactor Models
- Arbitrage Portfolio Theory (APT) – A Multifactor Macroeconomic Model
- Risk Factors and Tracking Portfolios
- Markowitz, MPT, and Market Efficiency
- International Capital Market Integration
- Domestic CAPM and Extended CAPM
- Changes in Real Exchange Rates
- International CAPM (ICAPM) - Beyond Extended CAPM
- Measuring Currency Exposure
- Company Stock Value Responses to Changes in Real Exchange Rates
- ICAPM vs. Domestic CAPM
- The J-Curve – Impact of Exchange Rate Changes on National Economies
- Moving Exchange Rates and Equity Markets
- Impacts of Market Segmentation on ICAPM
- Justifying Active Portfolio Management
- The Treynor-Black Model
- Portfolio Management Process
- The Investor Policy Statement
Adding an Asset to a Portfolio – Improving the Minimum Variance Frontier
We can use the Sharpe Ratio to determine if adding an asset creates a better (higher) minimum variance frontier.
The Sharpe ratio is calculated using the following formula:
Sharpe Ratio = (E(Rasset) – RF)/σasset
Calculate the Sharpe ratio for the current portfolio and then calculate the Sharpe ratio after adding the new asset.
If the Sharpe Rationew port > (Sharpe Ratiocurrent port * ρ(new asset, current port)), then the new asset should be added.
ρ(new asset, current port) = correlation coefficient between the current portfolio’s returns and the new asset’s returns
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