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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 years return is anyones 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% Govt 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). = = = T i i R R T R Var 1 2 2 ) ( 1 1 ) ( Var(R) SD(R) = = Figure 12.10 Portfolios A portfolio is a collection of assets, such as stocks & bonds An assets 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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 Winter '08
 WELLMAN, J

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