Class 9 - o Ex 25 of $ in C 75 in A ROR =.25(C’s expected...

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Ch. 7: Risk and Return Risk and return: o Realized rate of return: Measures gain/ loss on an investment over a past period o Expected rate of return: What you expect to earn going forward o Variability in returns: Standard deviation is square root of variance o Arithmetic vs. geometric average rates of return: Geometric: What was the growth rate of your investment? ROR for multi-year horizon Accounts for compounding (thus, is lower than arithmetic) Arithmetic: Simply what was the average ROR of all your years ROR just for next year No look at return on portfolio of securities (more than 1):
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Unformatted text preview: o Ex. 25% of $ in C, 75% in A: ROR = .25(C’s expected ROR) + .75(A’s expected ROR) o Evaluating portfolio risk: Typically lower variability than its individual parts Depends on correlations between individual securities Correlation coefficients between -1 and +1 As long as investments aren’t perfectly correlated, there will be some reduction in risk • Key is to combine securities that don’t “move together” Simple weighted average SD is greater than SD formula that accounts for correlations Correlation of -1 is most desirable...
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