RiskandRatesofReturn-FloridaInternationalUniversity.docVIP

Risk and Rates of Return Risk – The chance that some unfavorable event will occur; investment risk can be measured by the variability of the investment’s return. Stand-Alone Risk Probability Distributions Subjective (estimated) Objective (historical) Continuous Discrete Expected Rate of Return … weighted average of all possible outcomes … the rate of return expected to be realized from an investment … the mean value of the probability distribution of possible results Variance ((2) Standard Deviation (() … measures total risk Coefficient of Variation (CV = (/k) … measures risk per unit of return … can be used to rank stocks based upon their risk/return characteristics … the CV is most useful when analyzing investments that have different expected rates of return and different levels of risk Risk Aversion … the greater a security’s risk, the greater the return investors will demand and thus the less they are willing to pay for the investment Risk Premium …the portion of a security’s expected return that is attributed to the additional risk of an investment over and above the “risk-free” rate of return Portfolio Risk Portfolio – a collection or grouping of investment securities or assets Efficient Portfolio Maximize return for a given level of risk Minimize risk for a given level of return Portfolio Return … the expected return on a portfolio, kp, is the weighted average of the expected returns on the individual stocks in the portfolio … the portfolio weights must sum to 1.0 … the realized rate of return is the return that is actually earned on a stock or portfolio of stocks Portfolio Risk … the riskiness of a portfolio of securities, (p, in general is not a weighted average of the standard deviations of the individual securities in the portfolio … the correlation coefficient, r, is a measure of the degree of co-movement between two variables; in this case, the variable is the rate of return on two stocks over some past period … -1.0