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RISK_AND_RETURN_1_

# RISK_AND_RETURN_1_ - Finance 300 Risk Return Return...

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Finance 300 Risk & Return Return: Expressed as percent. Actual Return: R(t) = (P t - P t-1 + CF)/ P t-1 Problems with the measure of return: Risk: is used interchangeably with uncertainty to refer to the variability in returns for a given asset. If the actual return can be quite different from the expected, then there is uncertainty (variability) in the returns. T-Bills vs Speculative Stock. Measuring Expected Return E(r) = P 1 * r 1 + P 2 * r 2 +...+P n * r n Measuring Risk: Stand Alone Standard Deviation = SUM ((r i ) – E(r))^ 2 * P i )^ .5 EVENT PROB RETURN A(rA) RETURN B (rB) Strong .25 20% -4% Normal .5 12% 8% Weak .25 -8% 12% Expected return for A = (.25 * 20 + .5 * 12 + .25 * -8) = 5 + 6 - 2 = 9% Expected return for B = 6% Variance for A = (20 - 9)^ 2 * .25 +(12 - 9)^ 2 * .5 +(-8 - 9)^ 2 * .25 = 30.25 + 4.5 + 72.25 = 107 Variance for B = (-4 – 6)^ 2 * .25 +(8 – 6)^ 2 * .5 +(12 – 6)^ 2 * .25 = 25 + 2 + 9 = 36 Standard Deviation for A (sd) = 10.3441 Standard deviation for B (sd) = 6 Chebyshev's Theorem 1 sd: 68.3% 2 sd: 95.5% 3 sd: 99.7% Coefficient Of Variation (lowest value) c.v. = s.d./E(r) c.v. for A = 1.15 c.v. for B =______ Given 50% in A and 50% in B EVENT PROB RETURN A(rA) RETURN B (rB) RETURN A&B (rAB) Strong .25 20% -4% 8% Normal .5 12% 8% 10% 1

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