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Chapter 8 - Chapter 8 Risk and Return Theories I portfolio...

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Chapter 8: Risk and Return Theories: I - portfolio theory deals with the selection of portfolios that maximize expected returns consistent with individually acceptable levels of risk - capital market theory deals with effects of investor decisions on security prices - risk and return relationship indicates how much an asset’s expected return should be, given its relevant risks Asset pricing model – risk and return relationship Measuring Investment Return: - return on an investor’s portfolio is equal to change in value of portfolio plus any distributions received from portfolio, expressed as a fraction of initial portfolio value R p = (V 1 – V 0 + D)/ V 0 V 1 = portfolio market value at end, V 0 = portfolio market value at beginning, D = cash distributions to investor - assumes no capital inflows, any interest or dividend income is reinvested in portfolio - if two investments have same return but one investment makes cash payments early and the other late, the one with early payment will be understated - we cannot rely on preceding formula to compare return on 1-month investment with a 10-year portfolio; usually convert to annual period return Arithmetic average rate of return – unweighted average of returns achieved during a series of such measurements intervals R A = (R P1 + R P2 + … + R PN ) / N R A
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