L3B Financial Metrics

for designing your portfolio, developing strategies and understanding the behaviour

Risk type	Source and examples	Also known as
Systematic risk	From events that cannot be planned: • Financial crisis (Lehman Brothers, 2008) • Global pandemics (COVID-19) • Wars (US–Iran, 2026) • Undiversifiable risk	Market Macro
Unsystematic risk	From individual companies or sectors: • New technologies • Changes in oil prices • Diversifiable risk	Individual Idiosyncratic Specific Micro

Sharpe Ratio

Sharpe Ratio = \frac{R - R _{f}}{σ _{p}} where: R: the return on the portfolio R_{f} : the risk free rate of return σ_{p} : Standard deviation of the portfolio’s excess return

Beta Coefficient, β = \frac{Covariance ( R , R _{m} )}{Variance ( R _{m} )} where: R: the return on the portfolio R_{m} : the return on the market

covariance - relation between movement of 2 assets

β_{p} = i = 1 \sum n w_{i} β_{i}

A portfolio’s overall beta is the weighted average of its assets’ betas, where $w_{i}$ is each asset’s portfolio allocation.
Allocating more to high-beta assets raises systematic risk; allocating more to low-beta assets reduces it. A market beta of $1$ is the benchmark.

Alpha Coefficient, α = R - R_{f} - beta (R_{m} - R_{f}) where: R: the return on the portfolio R_{m} : the return on the market R_{f} : the risk free rate of return beta: represents the systematic risk of the portfolio

expected return = risk-free return + compensation for market risk

E (R_{i}) = R_{f} + β_{i} [E (R_{m}) - R_{f}] Alpha = R - β * R_{m}

the degree with which one instrument moves in relation to another
ranges from -1 to +1 (standardised)
tells the relation but not the causation
$Correlation = \frac{C o v ( x , y )}{σ x * σ y}$