10 18 Average Stock Returns and Risk Free Returns US government securities have

10 18 average stock returns and risk free returns us

This preview shows page 18 - 25 out of 28 pages.

10-18
Image of page 18
10-19 The Risk-Return Tradeof The general rule: The more volatile (or risky) a return is, the greater the return will be expected to be.
Image of page 19
10-20 Risk Statistics There is no universally agreed-upon definition of risk. The measures of risk that we discuss are variance and standard deviation. Variance and standard deviation measure the dispersion of actual returns around the security’s mean return The standard deviation is the standard statistical measure of the spread of a sample, and it is the measure used in most cases. Its interpretation is facilitated by a discussion of the normal distribution.
Image of page 20
10-21 Normal Distribution A large enough sample drawn from a normal distribution looks like a bell-shaped curve. Probability Return on large company common stocks 99.74% – 3 – 48.8% – 2 – 28.6% – 1 – 8.4% 0 11.8% + 1 32.0% + 2 52.2% + 3 72.4% The probability that a yearly return will fall within 20.2 percent of the mean of 11.8 percent will be approximately 2/3. 68.26% 95.44%
Image of page 21
Normal DistributionThe return of large company stocks has a standard deviation of 20.2 from 1926 through 2012.That standard deviation can be interpreted as follows:
Image of page 22
10-23 Variance and Standard Deviation 23
Image of page 23
EXAMPLE – RETURN AND VARIANCE Year Actual Return Average Return Deviation from the Mean Squared Deviation 1 .15 .105 .045 .002025 2 .09 .105 -.015 .000225 3 .06 .105 -.045 .002025 4 .12 .105 .015 .000225 Totals .00 .0045 Variance = .0045 / (4-1) = .0015 Standard Deviation = .03873 10-24 Average Return = (15 + 9 + 6 + 12) / 4 = 10.5
Image of page 24
Image of page 25

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture