Year 1 · Foundations · Portfolio & Risk
Risk, Return & Diversification
Learn how finance measures return and uncertainty, why correlation matters as much as volatility, how portfolio risk differs from single-asset risk, and why diversification reduces some risks but never eliminates all uncertainty.
LEARNING OBJECTIVES
What you should be able to explain after this lesson
01
Calculate holding-period return, expected return and weighted portfolio return.
02
Explain variance and standard deviation as measures of dispersion rather than guaranteed future loss.
03
Calculate and interpret covariance and correlation.
04
Use the two-asset portfolio variance formula and explain the diversification effect.
05
Distinguish systematic risk from idiosyncratic risk.
06
Interpret the Sharpe ratio and recognize its limitations.
CONCEPT MAPFrom individual returns to portfolio risk
Return is compensation for deploying capital; risk is uncertainty around outcomes
CORE FACTS · SAME IN EVERY MODE
Return measures the economic gain or loss on invested capital over a defined period.
Risk is multidimensional: volatility, drawdown, credit loss, liquidity, concentration and tail outcomes capture different forms of uncertainty.
Higher expected return is not a guarantee of higher realized return.
A useful portfolio decision compares expected reward with the nature, size and timing of the risks required to earn it.
BeginnerTeaching style changes, knowledge does not.
If one investment might earn 8% but can move sharply up or down, while another pays a more stable 3%, the first does not automatically 'beat' the second. You need to understand how uncertain the 8% is, how much loss you could tolerate and how the investment behaves with the rest of your portfolio.
COMPARISON
Different meanings of risk
| Risk measure | What it captures | What it can miss |
|---|---|---|
| Volatility | Dispersion of returns | Direction and tail shape |
| Drawdown | Peak-to-trough loss | Probability before the event |
| Credit risk | Failure to meet contractual payments | Market volatility alone |
| Liquidity risk | Cost or difficulty of exiting | Fundamental value alone |
PROFESSIONAL VOCABULARYRealized return / rendement réalisé / realized return Expected return / rendement attendu / expected return
The return actually experienced over a completed period.
A probability-weighted or model-based expectation of future return.