Introduction to Risk, Return and the Historical Record. P.V. Viswanath For a First Course in INvestments. Learning Goals. How are interest rates determined? How can we compare rates of return for different holding periods? What is the relation between inflation rates and interest rates?
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For a First Course in INvestments
We have seen that financial portfolio returns are volatile. Investors need to consider the average return in comparison with the risk/volatility of portfolios.
The Sharpe Portfolio compares the average return on portfolios over and above the risk-free rate of return as a multiple of the volatility of this excess return.
Sharpe Ratio for Portfolios: [E(R)-Rf]/sd(R)
Note that this is not appropriate for individual assets
Returns appear normally distributed
Returns are lower over the most recent half of the period (1986-2009)
SD for small stocks became smaller; SD for long-term bonds got bigger
Better diversified portfolios have higher Sharpe Ratios