Financial Risk Manager Part 1

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A portfolio consists of two funds A and B. The weights of the two funds in the portfolio and the covariance matrix of the two funds are given in the following two exhibits.

Exhibit 1: Weight of the Funds in the Portfolio

Fund	A	B
Weight	60%	40%

Exhibit 2: Covariance Matrix

Fund	A	B
A	700	200
B	200	500

What is the portfolio variance?

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TTanishq

428

500

324

328

Explanation:

Based on the covariance matrix:

\text{Variance}_{\text{Portfolio}} = w_1^2 \sigma_1^2 + w_2^2 \sigma_2^2 + 2w_1w_2 \rho_{1,2} \sigma_1 \sigma_2

= 0.60^2 \times 700 + 0.40^2 \times 500 + 2 \times 0.60 \times 0.40 \times 200

= 0.36 \times 700 + 0.16 \times 500 + 0.48 \times 200

= 252 + 80 + 96 = 428

Covariance Matrix (repeated for clarity):

Fund	A	B
A	700	200
B	200	500

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