ch5outline - Chapter 5: Risk and Return: Past and Prologue...

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Chapter 5: Risk and Return: Past and Prologue I. Rates of Return A. A key measure of investors’ success is the rate at which their funds have grown during the investment period 1. The total holding period return(HPR) of a share of stock depends on the increase(or decrease) in the price of the share over the investment period as well as on any dividend income the share has provided B. The rate of return is defined as dollars earned over the investment period(price appreciation as well as dividends) per dollar invested C. HPR = (ending price – beginning price + cash dividend)/ beginning price 1. This definition of the HPR assumes that the dividend is paid at the end of the holding period 2. The definition ignores reinvestment income between the receipt of the dividend and the end of the holding period 3. The dividend yield- the percentage return from dividends a. The dividend yield plus the capital gains yield equals the HPR D. The HPR on a bond would be calculated using the same formula, except that the bond’s interest or coupon payments would take the place of the stock’s dividend payments E. Measuring investment returns over multiple periods 1. The holding period return is a simple measure of investment return over a single period 2. Measures of performance: the arithmetic average, the geometric average, and the dollar-weighted return 3. Arithmetic average a. The arithmetic average of the quarterly returns is just the sum of the quarterly returns divided by the number of quarters b. Since this statistic ignores compounding, it does not represent an equivalent, single quarterly rate of the year c. It’s the best forecast of performance in future quarters 4. Geometric average a. The geometric average of the quarterly returns is equal to the single per period return that would give the same cumulative performance as the sequence of actual returns b. We calculate this by compounding the actual period-by-period returns and then finding the equivalent single per- period return c. The geometric return is also called a time-weighted average return because it ignores the quarter-to-quarter variation in funds under management d. An investor will obtain a larger cumulative return if high returns are earned in those periods when additional sums have been invested, while lower returns are realized when less money is at risk e. The appeal of the time-weighted return is that in some cases we wish to ignore variation in money under management II. Risk an Risk Premiums
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A. Scenario Analysis and Probability Distributions 1. When we attempt to quantify risk, we begin with the question: What HPRs are possible, and how likely are they> a. A good way to approach this question is to devise a list of possible economic outcomes, or scenarios , and specify both the likelihood of each scenario and the HPR the asset will realize in that scenario this approach is called scenario analysis . b.
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This note was uploaded on 09/10/2010 for the course FIN 367 taught by Professor Han during the Fall '08 term at University of Texas at Austin.

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ch5outline - Chapter 5: Risk and Return: Past and Prologue...

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