In a two stock portfolio risk equation, we have three terms on the right side as under:
Variance of Stock 1 + Variance of Stock 2 + Covariance of Stocks 1 & 2
If I have to understand logically, how I should interpret? My reading is:
Since the portfolio has two stocks, the risk is contributed by three parts:
Deviation of returns of the first stock from its mean
Deviation of returns of the second stock from its mean
Simultaneous deviation of the two stocks from their means
All the three would be in proportion to their weights. Is this understanding correct? More importantly I am unable to understand how the third term contributes to the risk.
Edit - just saw you’re a level 2 Candidate. Your posting your question in CFA Level 1. you do realize that?. Disregard my comment
let me see if i can understand what your saying. from understanding. those 3 parts, your trying to find the correlation, which you already know how to. But since this is a two stock portfiolio, i’m guessing the risk has to be composoed of #3. that is simultaneous deviation of the two stock, which is the deviation of the portfolio itself… Hope this makes sense, but plz don’t take my answer as an understanding i’m still attempting to comprehend my self. Correct me if i’m wrong plz
Nope. This does not seem to help me. Neither this appears correct.
is your orginal OP related to a certain question? if it is , can you post it here?. Or are you just generally asking
Generally asking to understand the logic.