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August 23, 2006

Covariance and Calculation of Portfolio Variance

Now, let's go to the next step - calculation of the expected return, the variance and the standard deviation of our portfolio, consisting of the two assets: 60% of the asset A and 40% of the asset B. Future returns of the assets A and B are considered as a random variables R A è RB.

Expected return of the asset A is 10% and the standard deviation is 8.66%. Expected return of the asset B is 15%, the standard deviation is 12%.

The calculation of the portfolio expected return is a fairly straightforward. But the calculation of the standard deviation and variance of the portfolio is more complicated, because portfolio variability (standard deviation) is not the weighted-average of the variabilities of the individual assets. Diversification reduces the variability of the portfolio, because the prices of different assets vary differently. In many cases, the decrease in price of one asset is compensated by the price growth for another.

Continue reading "Covariance and Calculation of Portfolio Variance"

Posted by mazoo at 12:49 PM | Comments (1)

August 17, 2006

Calculation of the coefficient of variation

Let’s consider the two asset portfolio with 60% of the asset A and the 40% of the asset B. Each security’s future return is considered as a random variable (RA and RB). Our portfolio is a weighed combination of assets. The return of a portfolio is also a random variable and we can calculate portfolio expected return and the variance of the portfolio.

First, let’s calculate the expected return and the variance for asset A. Assume, that the asset A has the following estimated rate of return distribution:

Rate of Return                Probability
(-5%)                                  20%
10%                                    50%
20%                                    30%

The expected rate of return for RA is:


rA = (-5%)*0.2 + 10%*0.5 + 20%*0.3 = 10%

The formula for variance RA is:

= (-5-10)(-5-10)*0.2 + (10-10)(10-10)*0.5 + (20-10)(20-10)*0.3 = 75


Standard deviation is simply the square root of the variance:
= 8.66%
Let us assume that the asset B has the expected value of return rB = 15%, and the standard deviation of RB is 12%.


The standard deviation reflects the degree of risk for each individual assets A and B. When we want to compare the risk of different assets with the different expected return, we need to use the relative measure - the coefficient of variation:

Hence,asset's A coefficient of variation is: 8.66/10 = 0.866
             asset's B coefficient of variation is: 12/15 = 0.8
So, we can say that asset A is a riskier investment than asset B.


In the next post, we'll calculate the expected return of our portfolio, define the covariance and coefficient of correlation for two assets, and how these values affect the variance and the standard deviation of the portfolio.


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Posted by mazoo at 1:50 PM | Comments (2)

August 9, 2006

Business Strategy

Bcg_growth_shareAnswering the question asked in the comment, I decided to publish the link to the helpful  article. “Business strategy” article outlines the different approaches to analyzing business units, product lines, ways to grow the business and so on.

I learned the definitions of star, cash cow, dog and question mark (BCG Growth Share Matrix) from the article, that was very helpful.

 

Also, I recommend to examine the Five Forces of Competition Model diagam. This diagram was a good addition to my textbook. I like the visualisation, it helps me to understand better and more quickly.

Five_forces_expanded_lg

Posted by mazoo at 3:08 PM | Comments (1)

August 4, 2006

Revised CMA Part 3 - passed!

Last Tuesday I passed Revised CMA part 3 exam “Strategic Management” with  a score of 540.

I began the serious preparation in the middle of May, so it took more than two months.  The understanding of concepts did not seem difficult to me, since some concepts were partially covered  in part 1 “Business Analysis” and part 2 “Management Accounting and Reporting” materials (planning, bonds, ratios, etc.), and the Hock textbook presents the theory in a very clear way, as usual.

For the purpose of time saving during the preparation, I did not give much attention to the real options (only several pages that were in the Hock materials) and the calculation of covariance, hoping for only general questions on these topics.

While initially it seemed that third exam wouldn’t be very difficult, I read a lot of messages from IMA email exchange that part 3 “Strategic Management” of the Revised exam was the hardest... and it definitely was. So I was warned and decided to focus on trying to make calculations more accurate  and faster, and better understanding the concepts. This exam became a real challenge for me.

At first, I was faced with the time shortage again. I spent too much time on text questions, the most part of which were very tricky. When I answered all questions, I only have 10 minutes left.

Secondly, I marked near the 30 questions, so I wasn’t sure that one third of my answers were correct.

Thirdly, I got 7–10 questions about the real options and the calculation of covariance . The guessing in the latter was especially annoying because I think that these questions were very simple.

Honestly, when the last seconds of the exam were gone and I stared at the waving (as usual for Prometric) white screen, I was sure I failed. And when, after the long dramatic pause I received the congratulatory message, I was happy. 540 scores are not the brilliant result, but I passed and it is good!

The suggestions I would make are as follows:

1. If you need to learn the concepts before taking the exam – use Hock materials. If you really know the material and just need to refresh memory – use Gleim review, which includes much more materials and details, but less clear explanations than Hock. If you use Hock materials, be sure that you understand all topics, because Hock provides you with not only sufficient but also necessary information.

2. I used Gleim software. As usual, Gleim test prep has a lot of sly, complex and not aligned with LOS questions. I think that this is very good, since it prepares you for unexpected questions on the exam.

3. IMA Q&A books. These questions are highly representative of what you will see on the exam. But the average book question is more short and simplistic than the average exam question.

4. For better time management I answered all the text question first, then the short computational questions and 5 long computational questions for last. The good timing is very important.

That’s my report.

Posted by mazoo at 6:47 PM | Comments (11)