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Unformatted text preview: Chapter 13 Retur n, Risk and the Secur ity M ar ket Line Expected Returns • We can only talk about “returns” in the past tense. • In the future, we have expectations about returns, but no guarantees. • In this context, “expected” means the mean (or average) if the process is repeated many times. • E.g.: we may expect stocks to generate a 10% average annual return over time, but next year’s return is anyone’s guess. Average Returns, by Class Investment Average Return Large stocks 12.3% Small Stocks 17.1% Longterm Corporate Bonds 6.2% Longterm 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 81. The geometric returns are lower. For small stocks: N=81;PV=$ 1;FV=$13,706.15;PMT=0; CPT I/Y=12.61%. Large stocks: 10.49%. Corp. bonds: 5.96% Gov’t bonds: 5.54%. Tbills: 3.78% Note: all returns are nominal; adjust for the inflation rate to calculate real returns. 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 = Figure 12.10 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 riskreturn tradeoff for a portfolio is measured by the portfolio expected return and standard deviation, just as with individual assets 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?...
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This note was uploaded on 01/09/2010 for the course HADM 2225 taught by Professor Wellman, j during the Winter '08 term at Cornell.
 Winter '08
 WELLMAN, J

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