Chapter 11

Chapter 11 - 11-1Learning ObjectivesTo get the most out of...

Info iconThis preview shows pages 1–9. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: 11-1Learning ObjectivesTo get the most out of this chapter, spread your study time across:1. How to calculate expected returns and variancesfor a security.2. How to calculate expected returns and variances for a portfolio.3. The importance of portfolio diversification.4. The efficient frontier and importance of asset allocation.11-211-2Diversification and Asset AllocationOur goal in this chapter is to examine the role of diversification and asset allocation in investing.In the early 1950s, professor Harry Markowitz was the first to examine the role and impact of diversification.Based on his work, we will see how diversification works, and we can be sure that we have efficiently diversified portfolios. 11-311-3Expected ReturnsExpected return is the weighted average return on a risky asset, from today to some future date. The formula is:To calculate an expected return, you must first:Decide on the number of possible economic scenarios (states) that might occur.Estimate how well the security will perform in each states, andAssign a probability to each states[ ]==n1ssi,sireturnpReturnExpected11-411-4Calculating Expected Returns11-511-5Expected Risk PremiumDefine:Suppose riskfree investments have an 8% return. Then,The expected risk premium on Jpod is 20%-8%=12%The expected risk premium on Starcents is 25%-8%=17%rateriskfreereturnexpectedpremiumriskexpected-=11-611-6Calculating the Variance of Expected ReturnsThe variance of expected returns is calculated using this formula:The standard deviation is simply the square root of the variance.VarianceDeviationStandard==( 29[ ]=-==n1s2ss2returnexpectedreturnpVariance11-711-7Example: Calculating Expected Returns and Variances: Equal State Probabilities(1)(3)(4)(5)(6)(7)Return ifState ofStateExpectedDifference:Squared:Product:EconomyOccursReturn:(3) - (4)(5) x (5)(2) x (6)Recession-0.200.25-0.450.20250.10125Boom0.700.250.450.20250.10125Sum:0.202500.45(1)(3)(4)(5)(6)(7)Return ifState ofStateExpectedDifference:Squared:Product:EconomyOccursReturn:(3) - (4)(5) x (5)(2) x (6)Recession0.300.200.100.01000.00500Boom0.100.20-0.100.01000.00500Sum:0.010000.10(2)Probability ofState of Economy0.500.501.00Sum = the Variance:Standard Deviation:Jpod:(2)1.00Sum is Variance:Standard Deviation:Probability ofState of Economy0.500.5011-811-8Expected Returns and Variances, Starcents and Jpod11-9...
View Full Document

Page1 / 34

Chapter 11 - 11-1Learning ObjectivesTo get the most out of...

This preview shows document pages 1 - 9. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online