I am stuck with understanding how the CFA institute come up with some results in their port mgt book. go to page 351 in the actual CFA institute portfolio management book third paragraph… FROM “What if the correlation among stocks…” TO “110% of the minimum possible portfolio variance.” What I dont get is how they come up with the number of stocks needed in both cases, given the desired portfolio variance and the average correlation among stocks. I think it has to do the formula right above the paragraphs but I somehow dont get. A somewhat detailed explanation will be appreciated…Thanks again.
In general, for portfolio management, when you are looking for the number of stocks in a portfolio, they use computers to generate the value given the correlation and such… don’t know if that is what you are looking for. (did not get a chance to look at the reference page)
You must be studying very carefully to stuble on this one! I just did this chapter but just glossed over all that stuff! When they say they want the portfolio to have 110 percent of the minimum possible portfolio variance, you first need to know what the minimum possible portfolio variance is. Based on an avg correlation of 0.5, the minimum possible portfolio variance is 0.5 (check the paragraph above the one you mentioned for the reasoning) So if you want to know how many stocks you need to ensure that the portfolio variance is 110% of the minimum possible portfolio variance, you need to solve for n in: Using equation 66-6 but only the bit in brackets: ((1-p)/n + p) = 0.55 ((1 - 0.5)/n + 0.5) = 0.55 n = 10 …which is how many stocks you need (use 0.55 because you want it to be 110% of the minimum possible portfolio variance, which is 0.5) It’s kind of hard to explain…