Chapter 7: Risk Estimation and Diversification

The following sections are included:

• Introduction

• Risk Classification

  • Business risk

  • Financial risk

  • Total risk

• Portfolio Analysis and Application

  • Expected rate of return on a portfolio

  • Variance and standard deviation of a portfolio

  • The two-asset case

  • The N-asset case

  • The efficient portfolios

  • Corporate application of diversification

• The Market Rate of Return and Market Risk Premium

  • The risk premium

• Determination of Commercial Lending Rates

• The Dominance Principle and Performance Evaluation

• Summary

• Appendix 7A — Estimation of Market Risks Premium

• Appendix 7B — The Normal Distribution

• Appendix 7C — Minimum-Variance Approach to Derive Optimal Weight

• Appendix 7D — Sharpe Performance Approach to Derive Optimal Weight

• Appendix 7E — Solving Example 7.1 with Excel