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UNIVERSITY OF ILLINOIS College of Business - Department of Finance - Finance 300 (Financial Markets) Professor James Jackson Objective Risk-Return Methods: Expected Return and Covariance The study of the fields of economics, finance, business, and the international version of each of these fields are studies in the art and science of decision-making in a world of uncertainty. In this course, one of our goals is to develop decision-making skills that rely upon the concept of rational self-interest and objective reasoning, and that are consistent with a risk versus reward framework. In economics, finance, and business rational people try to make the best choices that they can with the information that is available, while maximizing the benefits and/or minimizing the costs or risks of a decision. One way to maintain this decision-making method is to employ a concept known as expected return , which is calculated in the following manner:   E(r) = ∑  Ρ  * r where    Ρ   = probability of success, r = Return of successful outcome. The generalized expected return equation above is designed so that we can compare the expected returns of various scenarios using probability or likelihood of occurrence of an events and/or the likely return on investment of the events . In order to generate an expected return, we must first estimate   Ρ r . A higher E(r) indicates a favorable scenario, while a lower E(r) indicates an unfavorable scenario.
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Standard Normal Distributions of Returns Single Asset 0.00% 0.25% 0.50% 0.75% 1.00% 1.25% 1.50% 1.75% 2.00% 2.25% -4.95 -4.60 -4.25 -3.90 -3.55 -3.20 -2.85 -2.50 -2.15 -1.80 -1.45 -1.10 -0.75 -0.40 -0.05 0.30
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This note was uploaded on 02/10/2011 for the course FIN 300 taught by Professor Staff during the Spring '08 term at University of Illinois, Urbana Champaign.

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