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Lecture 3 Sep 12 2011

Lecture 3 Sep 12 2011 - FINA 3104 FINA 3104 Investment...

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Unformatted text preview: FINA 3104 FINA 3104: Investment Analysis and Portfolio Management Lecture 3 – Two Determinants of Investment Decisions: Return and Risk Darwin Cho Darwin Choi September 12, 2011 Recap from Last Lecture Recap from Last Lecture • Real Assets and Financial Assets Financial Markets and The Econom • Financial Markets and The Economy • Why do we need financial markets? • Securities M M k t • Money Market, • Capital Market (Bond & Equity) • Derivatives • Indexes 2 Outline of Today ’s Lecture Outline of Today s Lecture • Arithmetic & Geometric Average Returns E t d R l i d R t & Ri • Expected vs. Realized Return & Risk • Value at Risk (VaR) • Risky, Riskfree Prospects & The Risk Premium • Risk Preferences & Returns Utility 3 Holdin Period Return Holding ‐ Period Return 1    t t t Div P P P t is the security price at time t P is the security price at time 1 1 1   t t t t t P r P t-1 is the security price at time t 1 Div t is income from time t and t-1 • Example: P = 50, P 1 = 53, P 2 = 54 D 1 = D 2 = 2 % 66 . 5 53 2 53 54 %, 10 50 2 50 53 2 1         r r 53 50 4 Arithmetic Average Return Arithmetic Average Returns • Simple average of returns earned over time:   r r r r n n      1 2 1 ...  A r   n t r n % 66 5 % 10   t n 1 % 83 . 7 2 % 66 . 5 % 10    • Assumes each period’s income is not reinvested, i di ( “i t t i t t”) i.e., no compounding (no “interest on interest”). 5 G t i A R t Geometric Average Returns • Root product of 1+return earned over time: 1 n 1 ) 1 ( / 1 1        n n t r  G r 1    t   1 ) 1 )( 1 )...( 1 )( 1 ( / 1 1 2 1       n n r r r r 1 2 1  n n   % 81 . 7 1 ) 0566 . 1 )( 10 . 1 ( 2 / 1    • Assumes each period’s income is reinvested, i di (th i “i t t i t t”) i.e., compounding (there is “interest on interest”)....
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Lecture 3 Sep 12 2011 - FINA 3104 FINA 3104 Investment...

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