449 words - 2 pages

Holding Period Return

HPR=(Ending price-Beginning price+Dividend during period one)/(Beginning price)=(P_1-P_0+D_1)/P_0

Dividend Yield: % return from dividends

Expected Return and Standard Deviation

E(r)=∑_s▒〖p_s r_s 〗

σ=√(∑_s▒〖p_s (r_s-E(r))〗^2 )

Expected end-of-year value of the investment =Dividend+Ending Price

Arithmetic and Geometric Averages

Arithmetic Mean (AM) =(∑▒HPR)/N

Better predictor of future performance

Geometric Mean (GM) = π(1+HPR) )^(1/N)-1

Better measure of past performance

GM < AM

Sharpe Ratio

Sharpe Ratio for Portfolios =(Excess Return)/(SD of Excess Return)=(R_i-R_f)/(σ(R_i-R_f))

Measure the attraction of an investment portfolio by comparing its reward (risk premium) and risk (SD)

Excess ...view middle of the document...

5Aσ^2

U=E(r)-0.005*A*σ^2

Utility value is used to facilitate cross asset comparison

Higher values are assigned to portfolios with more attractive risk-return portfolios

Utility score of risky portfolios = certainty equivalent rate of return

Portfolio is desirable only if certainty equivalent return > risk-free alternative

Certainty equivalent rate of return = the rate that risk-free investments need to offer to provide the same utility score as the risky portfolio

Undominated Assets

Dictated by the investor’s personal tradeoff between risk and return

Indifference Curve

Connects all portfolio points with the same utility value

Investor is indifferent between different assets on curve

Changes in Utility Changes in Level of Risk Averse

Step 2: Portfolio Return and Risk

Portfolio Return

r_p=W_1r1+W_2r2

Portfolio Risk

Variance=〖σ_p〗^2=〖W_1〗^2 〖σ_1〗^2+〖W_2〗^2 〖σ_2〗^2+2W_1 W_2 Cov(r_1,r_2)

=〖W_1〗^2 〖σ_1〗^2+〖W_2〗^2 〖σ_2〗^2+2W_1 W_2 σ_1 σ_2 ρ_12

Effect of Correlation on Portfolio Risk

*Perfectly positively correlated assets: Portfolio s.d is the average of the s.d of the assets in the portfolio

Diversification and Portfolio Risk

Market risk (common risk)

Systematic or nondiversifiable

Firm-specific risk

Diversifiable or nonsystematic

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