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Unformatted text preview: Chapter 8. Risk and Rates of Return 12/11/08 Table 81. Probability Distributions and Expected Returns Martin Products U.S. Water Rate of Rate of Economy, Probability Return Probability Return Which of This If This of This If This Af ects Demand Demand Product Demand Demand Product Demand Occurring Occurs (2)x(3) Occurring Occurs (5)x(6) (1) (2) (3) (4) (5) (6) (7) Strong 0.30 80% 24% 0.30 15% 4.5% Normal 0.40 10% 4% 0.40 10% 4.0% Weak 0.3060%18% 0.30 5% 1.5% 1.00 Expected return= 10% 1.00 Expected return= 10% We use Excel to do the calculations shown in black boldface type. TABLE 82. Calculating Martin Product’s Standard Deviation Rate of Deviation: Economy, Probability Return Actual  Which of This If This 10% Squared Af ects Demand Demand Expected Deviation Deviation Demand Occurring Occurs Return Squared x Prob. (1) (2) (3) (4) (5) (6) Strong 0.30 80% 70% 0.4900 0.1470 Normal 0.40 10% 0% 0.0000 0.0000 Weak 0.3060%70% 0.4900 0.1470 1.00 ∑ = Variance: 0.294 Standard deviation = square root of variance: σ = 0.5422 Standard deviation expressed as a percentage: σ = 54.2% TABLE 83. Finding σ Based On Historical Data Deviation from Squared Year Return Average Deviation (1) (2) (3) (4) 2005 30.0% 19.8% 3.9% 200610.0%20.3% 4.1% 200719.0%29.3% 8.6% 2008 40.0% 29.8% 8.9% Average 10.3% Variance = ∑: 25.4% Variance / (N1) = Variance/3: 8.5% Standard deviation = Square root of variance: σ = 29.1% Excel Function: STDEV(B41:B44) σ = 29.1% Expected Dol ars Percent of Product: Stock Return Invested (2)x(4) (1) (2) (3) (4) (5) Microsoft 12.00% $25,000 25.0% 3.000% IBM 11.50% $25,000 25.0% 2.875% GE 10.00% $25,000 25.0% 2.500% Exxon 9.50% $25,000 25.0% 2.375% 10.75% $100,000 100.0% 10.750% Figure 84. Returns With Perfect Negative Correlation, ρ = 1.0 Stocks W and M, held separately20% 15% 40% Rate of Return (%) Portfolio WM20% 15% 40% Rate of Return (%) Year Stock W Stock M Portfolio W M 2004 40%10% 15% 200510% 40% 15% 2006 40%10% 15% 200710% 40% 15% 2008 15% 15% 15% Avg return = 15.00% 15.00% 15.00% =AVERAGE(D88:D92) σ = 25.00% 25.00% 0.00% =STDEV(D88:D92)...
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This note was uploaded on 01/11/2012 for the course FIN 3403 taught by Professor Tapley during the Fall '06 term at University of Florida.
 Fall '06
 Tapley
 Finance

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