1.
Returns
A. Return = (amount received –
amount invested)/amount
invested
B.
Realized return  the return
received when bought & held until
maturity
C.
Expected rate of return – rate of
return expected to be realized from
an investment; weighted average of
the probability distribution of
possible results
= =
r i 1NriPi
Expected rate of return =
(expected ending value – cost) / cost
D.
Required return
Required return on a stock =
risk free return + premium for the
stock’s risk
2.
Investment risk
A.
Related to the probability of
earning a low or negative actual
return
B.
The greater the change of lower
than expected or negative returns,
the riskier the investment (more
risk = more return)
C.
Risk aversion – assumes investors
dislike risk & require higher rates
of return to encourage them to hold
riskier securities
(a) A less risky investment = risk
aversion
D.
Risk premium – the difference
between the return on a risky asset
& a riskless asset, which serves as
compensation for investors to hold
riskier securities
3.
standard deviation
A.
To calculate:
(a) Expected rate of return =
= =
r i 1NriPi
(b) Deviation
=

ri r
(c) Variance =
= =
(

σ2 i 1N ri
)
r 2Pi
(d) Standard deviation
=
= =
(
 )
σ i 1N ri r 2Pi
−
Use estimated standard
deviation if ONLY sample
returns over some past
period are available
(a)
Estimated
σ
= S =
=
(

t 1N rt
)

rAvg 2N 1
B.
measures total, or stand alone, risk
C.
the larger the standard deviation,
the lower the probability that actual
returns will be closer to expected
returns
D.
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 Spring '09
 caples
 Standard Deviation, Capital Asset Pricing Model, Ri

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