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Chapter_13__incl._Ch._12_slides_Presentation

# Chapter_13__incl._Ch._12_slides_Presentation - 13 Return...

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13 Return, Risk, and the Security Market Line

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13-2 Expected Returns Expected Returns Expected returns are based on the probabilities of possible outcomes In this context, “expected” means average if the process is repeated many times = = n i i i R p R E 1 ) (
13-3 Average Returns, by Class Average Returns, by Class Investment Average Return Large stocks 12.3% Small Stocks 17.4% Long-term Corporate Bonds 6.2% Long-term Government Bonds 5.8% U.S. Treasury Bills 3.8% Inflation 3.1% These are arithmetic averages: add up the yearly returns and divide by 80. The geometric returns are lower. For small stocks: N=80;PV=\$-1;FV=\$13,706.15;PMT=0; CPT I/Y=12.64%. Large stocks: 10.36%. Corp. bonds: 5.90% Gov’t bonds: 5.47%. T- bills: 3.71% Note: all returns are nominal; adjust for the inflation rate to calculate real returns.

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13-4 Risk: Standard Deviation Risk: Standard Deviation Variance and standard deviation measure the volatility of asset returns The greater the volatility, the greater the uncertainty Note that as your number of observations, T, increases, variance decreases. This is fairly intuitive: the more you observe something, the more predictable it becomes (at least up to a point). = - - = σ = T i i R R T R Var 1 2 2 ) ( 1 1 ) ( Var(R) SD(R) = σ =
13-5 Figure 12.10

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13-6 Portfolios Portfolios A portfolio is a collection of assets, such as stocks & bonds An asset’s risk and return are important in how they affect the risk and return of the portfolio The risk-return trade-off for a portfolio is measured by the portfolio expected return and standard deviation, just as with individual assets
13-7 Example 3: Portfolio Weights Example 3: Portfolio Weights Suppose you have \$15,000 to invest and you have purchased securities in the following amounts. What are your portfolio weights in each security? \$2000 of GE \$3000 of KO \$4000 of INTC \$6000 of PG Note the weights must add to 1.0 •w GE : 2/15 = .133 •w KO : 3/15 = .2 •w INTC : 4/15 = .267 •w PG : 6/15 = .4

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13-8 Portfolio Expected Returns Portfolio Expected Returns The expected return of a portfolio is the weighted average of the expected returns for each asset in the portfolio You can also find the expected return by
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