FIN301 - 1-110-1Chap. 10: Financial Assets’...

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Unformatted text preview: 1-110-1Chap. 10: Financial Assets’ Risk/Return–Reward for bearing risk in the primary form of price volatility/pain has been return, Over Time–Key is OVER TIME; short-term vagaries at times painful & illogical: e.g. 1929, Fall 1987 & Fall 2008 –The greater an asset’s risk/price volatility, the greater its potential reward—ceteris paribus–That said, dear SLU student, there’s an inverse relation between reward and price1-210-22Financial Markets’ “Raison Detre”Savers/investorshave the ability to invest in financial assets and build wealth; they defer present consumption in return for an indicated future return that is tied to the indicated level of price volatility/risk/pain of a given investment; higher that return/risk level the lower the priceBorrowers/publicly traded companies have access to capital available from savers—allowing them to finance/invest in productive assets1-310-3Let’s Look At and Discuss…•Figure 10.4: Generally speaking and ceteris paribus you are rewarded, over time, for taking on risk in the form of a level of price volatility/pain•Now, then, note on Table 1 that the stock market doesn’t go up every year: large-cap stocks plummeted 62% 1930-1932 in The Great Depression; stocks -37% 200831-410-4Risk Premiums Defined:•The excess return over and above the Risk-Free Rate/T-Bills required from an investment in a given Risky Asset to compensate you for the Risk of that asset; 1928-2009 around 5.5%•What does the Risk Premium mean in “Plain English”?•How do we gauge “price volatility”/pain?•What’s painful about price volatility?•Let’s consider Table 10.341-510-55Variance/Standard Deviation Measures Risk•To illustrate by way of example, consider a stock with the following yearly returns: +22%; +6%; +24%; -28%•Here we have a sample size (of all years) with N=4•Step one is to calculate the Arithmetic Average Return/AAR by dividing the total of the yearly returns by N=4; thus and so, AAR= +.061-610-6Variance/Standard Deviation Calculation: Bob Does on Board•We next calculate deviations for each year by subtracting AAR from the actual result for that year•We then square each of these deviations and, lastly, divide the sum of these squared deviations (I think of these as “partial variances”) by N-1 … to get the variance61-710-7Notice SLU student that you …•… divide the sum of the squares or the sum of the “partial results” by N-1 to remove Statistical Bias•Variance=.0579 and standard deviation (square Variance=....
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This note was uploaded on 03/18/2012 for the course FIN 301 taught by Professor Wike during the Spring '12 term at Saint Louis.

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FIN301 - 1-110-1Chap. 10: Financial Assets’...

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