Lecture 33 - Business Finance(ACC501 Lesson 33 Review of...

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172 Business Finance (ACC501) Lesson 33 Review of the Previous Lecture Returns Income Earned Capital Gains Percentage Returns Variability of Returns Topics under Discussion Variability of Returns (Cont.) Expected Return Expected Risk Portfolio Variability of Returns In general, the variance for T historical returns is : Var(R) = [(R 1 - R) 2 +……+(R T - R) 2 ] / (T -1) The standard deviation is always the square root of the variance. Year Company X Return Company Y Return 2000 -.20 .05 2001 .50 .09 2002 .30 -.12 2003 .10 .20 What are the average returns? variances? Standard deviations? Which investment was more volatile Company X average returns, R x = (-.20 + .50 + .30 + .10)/4 = .175 Company Y average returns, R Y = (.05 + .09 - .12 + .20)/4 = .055 Now we calculate variance for Company X Year Actual Return Average Return Deviation from the Mean Squared Deviation 2000 -.20 .175 -.375 .140625 2001 .50 .175 .325 .105625 2002 .30 .175 .125 .015625 2003 .10 .175 -.075 .005625 Totals .70 .000 .267500
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173 • Summarizing the calculations: Company X Company Y Variance ( σ 2) .2675/3 = .0892 .0529/3 = .0176 Standard Deviation ( σ ) .0892 = .2987 .0176 = .1327 Standard deviation for company X, 29.87% more than twice Company Y’s 13.27%. This indicates that company X is more volatile investment. Expected Return Consider a single period of time, say a year. We have two stocks, L and U. and they are expected to have a return of 25% and 20% respectively in the coming year Why to invest and hold stock U?
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