FIN301CHAPTER11(2)

FIN301CHAPTER11(2) - 1-111-1Ch. 11: Risk &...

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Unformatted text preview: 1-111-1Ch. 11: Risk & ReturnFocus of Ch. 11 more on price volatility/risk/pain for futures situations versus historical situations (latter being the focus of Ch. 10)Lets begin our work by centering on Stock L Table 11.3 page 342 and calculating expected return of - 0.02 given perceived .80 odds of a Recession and .20 odds of a Boom and related respective returns under each of these scenarios of -.20 and .7011-211-2Futures Variance CalculationTo calculate variancetop of page 344we subtract from the indicated rate of return under each economic scenario the just-calculated expected return of -.02 (basically, were adding .02 here, right?) proceeding to square each of these deviations and then multiplying each of the squared deviations by their respective scenario probabilities 21-311-3Futures Variance CalculationThe sum of these 2 and only 2 in this example squared deviations multiplied by each of their respective scenario probabilities = the variance =.1296Square root of the variance=standard deviation=0.36Notice that when working with futures and applying given probabilities to the square deviations theres no need to divide by N-131-411-4jiijijij2iiportn1in1iijjn1ii2i2iportrCovwherej,andiassetsfor return ofratesebetween thcovariancetheCoviasset for return ofratesofvariancetheportfolioin thevalueofproportionby thedeterminedareweightswhereportfolio,in theassetsindividualtheofweightstheWportfoliotheofdeviation standardthe:whereCovwww=====+= ===Switching our focus when calculating variance/standard deviation for a portfolio you need to use the following formula41-511-5The key to this formula which is also shown on Blackboard as slide # 8 in the Portfolio Standard Deviation stack is the covariance termCovariance measures the absolute degree to which the returns of 2 assets do or dont move together, over time, relative to each of the 2 assets individual meansAs an aid to our understanding, lets now look at a covariance calculation51-611-6A sample covariance calculationAssume you have 2 securities A & B and that over the past three years per-year returns were, +15%, -20%, +20% (A) & -10%, +10%, -15% (B)It would appear at first glance that theres a tendency for A to do well when B doesnt do wellIf so, we could end up with negative covarianceTo see for sure we calculate covariance of the 2 assets which, again, measures the absolute degree to which the returns of the 2 assets do or dont move together, over time, relative to their individual respective means61-7...
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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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FIN301CHAPTER11(2) - 1-111-1Ch. 11: Risk &...

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