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Unformatted text preview: 11111Ch. 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 .70112112Futures Variance CalculationTo calculate variancetop of page 344we subtract from the indicated rate of return under each economic scenario the justcalculated 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 213113Futures 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 N1314114jiijijij2iiportn1in1iijjn1ii2i2iportrCovwherej,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 formula415115The 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 calculation516116A sample covariance calculationAssume you have 2 securities A & B and that over the past three years peryear 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 means617...
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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.
 Spring '12
 wike
 Volatility

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