Chapter+11 - Chapter 11 Example: Expected Returns State (i)...

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1-1 Example: Expected Returns n 1 i i i R p ) R ( E State (i) p(i) E(Ra) E(Rb) Recession 0.25 -20% 30% Neutral 0.50 15% 15% Boom 0.25 35% -10% E(R) 1.00 25% 20% Stock A Stock B E(R) Variance and Standard Deviation • Variance and standard deviation measure the volatility of returns • Variance = Weighted average of squared deviations • Standard Deviation = Square root of variance n 1 i 2 i i )) R ( E R ( p 2 σ Variance & Standard Deviation State (i) p(i) E(R) DEV^2 x p(i) Recession 0.25 -20% 10% 0.0244141 Neutral 0.50 15% 2% 0.0112500 Boom 0.25 35% 6% 0.0141016 1.00 11.3% 0.0497656 22.3% State (i) p(i) E(R) DEV^2 x p(i) Recession 0.25 30% 3% 0.0076563 Neutral 0.50 15% 2% 0.0112500 Boom 0.25 -10% 5% 0.0126563 1.00 12.5% 0.0316 17.8% Standard Deviation Standard Deviation Stock B Expected Return Variance Stock A Expected Return Variance Portfolios • Portfolio = collection of assets • An asset’s risk and return impact how the stock affects the risk and return of the portfolio • The risk-return trade-off for a portfolio is measured by the portfolio expected return and standard deviation, just as with individual assets Portfolio Expected Returns • The expected return of a portfolio is the weighted average of the expected returns for each asset in the portfolio • Weights (w j ) = % of portfolio invested in each asset m 1 j j j P ) R ( E w ) R ( E Example: Portfolio Weights Dollars % of Pf w(j) x Asset Invested w(j) E( Rj ) E( Rj ) A $15,000 30% 12.5%
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This note was uploaded on 11/04/2011 for the course FIN 101 taught by Professor Staff during the Fall '11 term at Texas State.

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Chapter+11 - Chapter 11 Example: Expected Returns State (i)...

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