chpt07 - EstimatingReturnandRisk Chapter7...

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1 Estimating Return and Risk Chapter 7 Jones, Investments: Analysis  and Management

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2 Investment Decisions Involve uncertainty Focus on expected  returns Estimates of future returns needed to  consider and manage risk Goal is to reduce risk without  affecting returns Accomplished by building a portfolio Diversification is key
3 Dealing With Uncertainty Risk that an expected return will not  be realized Investors must think about return  distributions, not just a single return Use probability distributions A probability should be assigned to  each possible outcome to create a  distribution Can be discrete or continuous

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4 Calculating Expected  Return Expected value  The single most likely outcome from a  particular probability distribution The weighted average of all possible  return outcomes Referred to as an ex ante or expected  return i m 1 i i pr R ) R ( E = =
5 Calculating Risk Variance and standard deviation  used to quantify and measure risk Measures the spread in the probability  distribution Variance of returns:  σ 2  = Σ  (R i  - E(R)) 2 pr i Standard deviation of returns: σ  =( σ 2 ) 1/2 Ex ante rather than ex post  σ  relevant

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6 Portfolio Expected  Return Weighted average of the individual  security expected returns Each portfolio asset has a weight, w,  which represents the percent of the  total portfolio value The expected return on any portfolio  can be calculated as: = = n 1 i i i p ) R ( E w ) R ( E
7 Portfolio Risk Portfolio risk not simply the sum of  individual security risks Emphasis on the risk of the entire  portfolio and not on risk of individual  securities in the portfolio Individual stocks are risky only if  they add risk to the total portfolio

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This note was uploaded on 04/20/2010 for the course FCBA MBA608 taught by Professor Dr. during the Spring '10 term at Baptist College of Health Sciences.

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chpt07 - EstimatingReturnandRisk Chapter7...

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