the expected return, E(r), as   E(r) Pr(s)r (s) s   (6.2) Applying this formula to the case at hand, with three possible scenarios, we find that the expected rate of return of Best Candys stock is   E(rBest) (.5 25) (.3 10) .2( 25) 10.5%   Rule 2 The variance of an assets returns is the expected value of the squared deviations from the expected return. Symbolically,     Therefore, in our example   2 Pr(s)[r(s) E(r)]2 s   (6.3)   2 Best   .5(25 10.5)2 .3(10 10.5)2 .2( 25 10.5)2 357.25   The standard deviation of Bests return, which is the square root of the variance, is 357.25 18.9%. Humanex has 50% of its endowment in Bests stock. To reduce the risk of the overall portfolio, it could invest the remainder in T-bills, which yield a sure rate of return of 5%. To derive the return of the overall portfolio, we apply rule 3.   Rule 3 The rate of return on a portfolio is a weighted average of the rates of return of each asset comprising the portfolio, with portfolio proportions as weights. This implies that the expected rate of return on a portfolio is a weighted average of the expected rate of re- turn on each component asset.     2 The portfolio is admittedly unusual. We use this example only to illustrate the various strategies that might be used to control risk and to review some useful results from statistics. II. Portfolio Theory 6. Risk and Risk Aversion The McGraw−Hill Companies, 2001