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Expected Rates of Return

Expected Rates of Return - Expected Rates of Return In...

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1-1 Expected Rates of Return In previous examples, we discussed realized historical rates of return. In contrast, an investor would be more interested in the expected return on a future risky investment. Risk refers to the uncertainty of the future outcomes of an investment There are many possible returns/outcomes from an investment due to the uncertainty Probability is the likelihood of an outcome
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1-2 Expected Rates of Return Computing Expected Rate of Return where P i = Probability for possible return i R i = Possible return i = × = n i 1 i Return) (Possible Return) of y Probabilit ( ) E(R )] R (P .... ) )(R (P ) )(R [(P n n 2 2 1 1 + + + = = = n i i i R P 1 ) )( (
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1-3 Probability Distributions Exhibit 1.2 Risk-free Investment 0.00 0.20 0.40 0.60 0.80 1.00 -5% 0% 5% 10% 15%
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1-4 Probability Distributions Exhibit 1.3 Risky Investment with 3 Possible Returns 0.00 0.20 0.40 0.60 0.80 1.00 -30% -10% 10% 30%
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1-5 Probability Distributions Exhibit 1.4 Risky investment with ten possible returns 0.00 0.20 0.40 0.60 0.80 1.00 -40% -20% 0% 20% 40%
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1-6 Risk of Expected Return Risk refers to the uncertainty of an
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