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Unformatted text preview: Chapter 11 Risk and Rates of Return Defining and Measuring Risk Risk is the chance that an outcome other than expected will occur Probability distribution is a listing of all possible outcomes with a probability assigned to each must sum to 1.0 (100%) Probability Distributions It either will rain, or it will not only two possible outcomes Outcome (1) Probability (2) Rain 0.40 = 40% No Rain 0.60 = 60% 1.00 100% Probability Distributions Martin Products and U. S. Electric Expected Rate of Return The rate of return expected to be realized from an investment over a long period of time The mean value of the probability distribution of possible returns The weighted average of the outcomes, where the weights are the probabilities Expected Rate of Return Expected Rate of Return P Discrete Probability Distributions The number of possible outcomes is limited, or finite Discrete Probability Distributions Continuous Probability Distributions The number of possible outcomes is unlimited, or infinite Continuous Probability Distributions Measuring Risk: The Standard Deviation A measure of the tightness, or variability, of a set of outcomes Calculating Standard Deviation 1. Calculate the expected rate of return 2. Subtract the expected rate of return from each possible outcome to obtain a set of deviations P 3. Square each deviation, multiply the result by the probability of occurrence for its related outcome, and then sum these products to obtain the variance of the probability distribution Calculating Standard Deviation 4. Take the square root of the variance to get the standard deviation Calculating Standard Deviation Calculating Martin Products Standard Deviation Measuring Risk: The Standard Deviation What actually we want to know? Measuring Risk: Coefficient of Variation Standardized measure of risk per unit of return Calculated as the standard deviation divided by the expected return Useful where investments differ in risk and expected returns...
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This note was uploaded on 12/12/2011 for the course ECONOMICS 101 taught by Professor Thoman during the Spring '09 term at Abu Dhabi University.
 Spring '09
 thoman

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