Asset Classes
16 min
An asset class is a category of investments with similar characteristics and risk/return behavior: equities (stocks — ownership, variable return), fixed income (bonds — a loan, a predetermined interest schedule), cash/cash-equivalents (near-zero risk, near-zero return), real estate, and commodities are the most common. Every asset class shares one universal calculation — the return over a period:
def simple_return(price_start, price_end):
return (price_end - price_start) / price_start
print(simple_return(100, 110)) # 0.1 -- a 10% return
The formula never changes across asset classes -- what changes is the TYPICAL magnitude and volatility of the return, which is exactly what defines each asset class's risk profile.
A portfolio mixes multiple asset classes — the whole point of diversification is that different asset classes don't move together, so a mix is less volatile than any single asset class alone. The portfolio's overall return is a weighted average, weighted by how much of the portfolio each asset class makes up:
returns = [0.08, 0.03, 0.01] # stocks, bonds, cash
weights = [0.6, 0.3, 0.1] # 60% stocks, 30% bonds, 10% cash
portfolio_return = sum(r * w for r, w in zip(returns, weights))
print(round(portfolio_return, 4)) # 0.058 -- 5.8%
This is exactly a dot product — the same computation from the Linear Algebra course, applied to portfolio construction instead of abstract vectors. That connection (portfolio math IS linear algebra) only gets more central as you go further into quant finance.
Write `simple_return(price_start, price_end)`, returning `(price_end - price_start) / price_start` rounded to 4 decimals — the basic return calculation that applies to every asset class.
Write `portfolio_weighted_return(returns, weights)`, returning the weighted-average return across a mix of asset classes — a dot product of `returns` and `weights`, rounded to 4 decimals.
What's the defining difference between 'equity' (stocks) and 'fixed income' (bonds) as asset classes?
You know the major asset classes and can compute both a single asset's return and a portfolio's blended return across a mix of asset classes.