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Exam 2 Review

# Exam 2 Review - FINA 3332 Exam 2 Chapter Review Spring 2011...

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FINA 3332 Exam 2: Chapter Review Spring 2011 Chapter 6: Analysis of Risk and Return Risk o The possibility that actual returns, or cash flows, will be different from expected returns o Refers to the potential variability of returns from an asset or a portfolio of assets o Returns reflect cash flows o Risk-free returns are known with certainty Outcomes and Probability o Outcome —different possible events that may occur o Probability —the likelihood of each outcome o Return outcomes and their probabilities are used to obtain statistical measures of risk and return. Two data types o Subjective or personal determination Forward projections Uses ex ante data o Historical Actual past observations Uses ex post data Expected Return r = j=1nrjpj r = Expected return r j = return outcome j p j = probability of the j th outcome n = number of possible outcomes o o Mean, or average, value of possible return outcomes o Weighted average of the possible return outcomes Standard Deviation of Returns σ=j=1n(rj-r2pj ) r = Expected return r j = return outcome j p j = probability of the j th outcome n = number of possible outcomes σ = standard deviation σ 2 = variance o o Measures variability of returns from the mean o Indicates risk of an asset 1

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[Type text] [Type text] Normal Probability Distribution o Mean o Standard Deviation o Daily stock returns follow this Z-Tables = z Target Value –Expected ValueStandard Deviation Historical Data o Find Expected Return o Find Standard Deviation Subjective Data o Find Expected Return o Find Standard Deviation Coefficient of Variation o Measures Relative Risk o Measures total risk per unit of expected return CV= σr o Appropriate measure of total risk when comparing two investment projects or assets of different size Covariance o Measures the degree of co-movements of returns between pairs of assets (+) - on average, the asset prices move in the same direction (-) - on average, the asset prices move in opposite directions (0) – on average, there is no relationship between asset returns , σA B = = ( , - )( , - )( ) j 1n rA j rA rB j rB pj o First Calculate mean returns of each Expected return o Second, Calculate Covariance Correlation o Measures degree of co-movement of returns o Unit-less number between -1 and +1 inclusive o , = + ρA B 1 Perfectly positive correlation o , = - ρA B 1 Perfectly negative correlation o , = ρA B 0 No relationship o , = , ρA B σA BσAσB o Risk-Return Relationship o Required Rate of Return
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Exam 2 Review - FINA 3332 Exam 2 Chapter Review Spring 2011...

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