Expected Return Portfolio Management

EU Business School                                                              February 16, 2017

Prof. Isabel Salvat

Portfolio Management

Isabella Gomes Lustoza

Expected Return of a Portfolio

1. Concept:

The expected return is the percentage amount that an investor expects to gain from a portfolio when starts to invest in. This is a calculation of an expectation, and could change to higher or lowest amount, depending on the volatilities of its securities.

A return is the gain or loss a security generates of a period of time. Buying a stock for “X” dollars that pays an annual dividend of “Y” dollars, after a period of time the same investor sells its securities for X + 10 + Y; the investors return will be the 10 dollars + the dividend amount divided by the stock price (X).

These expectations are based on the assumption on how the stocks behaved on the previous period of time and the expected return of it and the proportional weight in a portfolio.

By calculating the expected return of a portfolio, the investor will have a better understand of its results and the possibility to plan its profits expectations to build a diverse portfolio.

1. Relationship between risk and expected return:

Better returns mean more satisfied investors. Generally, the higher is the risk the higher will be the return of it. The same time that a higher risk has a higher potential for profit, it also has a higher potential for loss. 

1. Portfolio diversification:

Portfolio diversification is an effective way to lower the risk and generate return, since not all the investment will be concentrated on only one kind of security. By allocating the capital in a variety of assets reduces the exposure to any particular high risk from a individual asset.

“Don’t put all the eggs in one basket”.

A portfolio can be diversified with low-risk as government bonds and high-risk as startups. Different levels of risk managed in the same portfolio are able to maximize the return while minimizes the volatility and loss.

1. Calculations:

To calculate the expected return of a portfolio with different securities, it is necessary to know each expected return and weight.

1. Formula:

[pic 1] , the expected return formula is the sum of the weights x the expected rate of return.

Rp = w1R1 + w2R2

• Rp = expected return for the portfolio
• w1 = proportion of the portfolio invested in asset 1
• R1 = expected return of asset 1

1. Example:

Portfolio of 3 different types of securities:

Total Investment: $800,000

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