Finance 300
Risk & Return
Return: Expressed as percent.
Actual Return: R(t) = (P
t
 P
t1
+ CF)/ P
t1
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.
TBills 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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 Spring '10
 BOUDREAUX
 Interest Rates, Capital Asset Pricing Model, 10%, 9%, 2%

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