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# risk - G o a ls Return R is k a n d R e tu r n s p a r t 1...

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1 Risk and Returns: part 1 Economics 71a: Spring 2007 Mayo chapter 8 Malkiel, Chap 9-10 Lecture notes 3.2a Goals Return reminder What is risk? Types of risk Statistics background Risk return tradeoff Returns Total percentage gain on investment Includes dividends for stocks Example Price : 100 - 105 Pays: \$2 dividend Return = (105+2-100)/100 = 7% What is Risk? Hard question No good answer Statistical Features Variance/Standard deviation Histograms (probability distributions)

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2 Types of Risk Market Default (financial risk) Business Interest rate Liquidity Tax Event Political Statistics Random variables and histograms Expected returns Variances Covariance Correlation Histogram Frequency with which random variable takes value Gives a pictorial indication of risk Many possible shapes Most famous is the Normal Distribution Random Variables and Histograms
3 Return Histogram Expected Return, E(R) N states of the world, 1, 2, ..,N

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