Risk and Return - RiskandReturn LearningOutcomes...

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Risk and Return Professor David McLean Alberta School of Business
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Learning Outcomes Prerequisites: Recall some basic statistics Mean, variance, standard deviation, covariance, and correlation Measuring risk and returns for a single asset Mean and variance Measuring risk and returns for a portfolio Mean, variance, covariance and correlation Risk Aversion 2
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Returns and Risk Investing is all about delaying consumption and taking risk in exchange for an expected return I use the term “expected” because returns are usually not known ahead of time. The only exception to this is with a risk free asset Investments are risky when you don’t know for sure what your return will be Hence, in order to evaluate an investment we need to estimate its expected return and its risk 3
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Expected  Returns 4 What return should you expect to get from an investment? The mean or expected return for an asset is the probability weighted average of the returns from all scenarios s 1 i i i r p E(r)
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Expected Return Example scenari o p r 1 .3 3% 2 .4 6% 3 .2 8% 4 .1 -10% 5 E (r) = (0.3 * 3%) + (0.4 * 6%) + (0.2 * 8%) + (0.1 *-10%) E (r) = 3.9%
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Holding-Period Return (HPR) How do you measure an investment’s realized return? Holding-Period Return (HPR) Rate of return over a given investment period HPR= [PE − PB + CF] / PB PE = Ending price PB = Beginning price CF = Cash flow during holding period 6
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Holding Period Return Example Ending Price = 110 Beginning Price = 100 Dividend =14 7 4% 2 100 14 100 110 HPR
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Let’s Discuss Risk We’ll consider the variance (or standard deviation) of an asset’s return to be its risk Asset returns with larger variance or
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