•
To get the
historical average of the individual values
we add up the yearly returns and divide by
80. Average returns are nominal because we aren’t worried about inflation. Historical Tbills have had low
real returns where as small stock have had relatively large real returns.
•
TBills have the lowest maturity of any government bond. Because the government can always raise
taxes to pay its bills, the debt represented by tbills is virtually free of default risk over its short life. The we
call the rate of return on tbills the
risk free return
and we will use it as a benchmark.
•
To calculate variance
:1
st
find average return = (r1 +r2 +r3…/3 or # of periods):Than find the
deviatons (r1 avg ret), (r2avg ret) etc…:Square the result and add them together:
Variance can now be
found by:
(Sum of Sq. Deviations)/ (number of returns 1):
After calculating Variance we can than
calculate Standard deviation simply by taking the square root of the variance.
•
Standard deviation is an ordinary %. Under normal distribution the probability we will end up within
one STDEV of the average is 2/3, two STDEV is 95%, and more than three STDEV is less than 1%.The
sharpe ratio
= risk premium of the assets/ STDEV; it is the measure of return relative to the level of risk
taken.
•
If a market is in
strong form
efficient
then all information of every kind is reflected in the stock
prices. There is no such thing as insider information.
Semistrong form efficient
is the most controversial,
it suggests all public information is reflected in the stock price. It implies that a securities analyst who tries
to indentify mispriced stock using financial statement information is wasting time because that information
has already been reflected in the stock price.
Weak form efficiency
suggests that at a minimum the
current price of a stock reflects the stocks own past prices. Studying past prices in attempt to indentify
mispriced securities is useless in weak form efficient.
•
To calculate the
variance of portfolio
we first determine the squared deviations from the expected
return and the risk free rate. We then multiply each possible squared deviation by its probability. Add these
up and the result is the variance. The standard deviation, as always, is the square root of the
variance.
Portfolio Weights
is the % of the total portfolio’s value that is invested in an asset. Using the
portfolio weight we can calculate the
expected portfolio return.(E(Rp)= Probability A x E(Ra) +
Probability B x E(Rb))
•
The unanticipated or surprise/innovation part of the return is the true risk of any investment.
Systematic Risk
is one that influences a large number of assets each to a greater or lesser extent because
systematic risk are marketwide they are often referred to as
market risk
. Types of systematic risk include:
GDP, Interest Rates, and Inflation.
Additionally, there is
unsystematic risk
or risk that affects a
small group of assets. Because these risk are unique to companies we often call them
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 Spring '11
 Craig
 Corporate Finance, isk, Systematic r isk, isk free rate

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