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Risk and Return: Historical Perspective

Risk and Return: Historical Perspective. Historical Returns Market Efficiency. Historical Returns 1926-2008. Average returns Arithmetic versus geometric Risk premium = Return – risk-free return Compensation for taking risk Standard deviation Measures variability of returns

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Risk and Return: Historical Perspective

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  1. Risk and Return: Historical Perspective • Historical Returns • Market Efficiency Capital Markets

  2. Historical Returns 1926-2008 • Average returns • Arithmetic versus geometric • Risk premium = • Return – risk-free return • Compensation for taking risk • Standard deviation • Measures variability of returns • Two-thirds of the time returns should fall: Capital Markets

  3. Can Stock B have the same Expected Return as Stock A??? Expected Return Capital Markets

  4. Historical Returns 1926-2008 10/15/99 Wall Street Journal, equity risk premium has fallen from 10% in early 1980s to 2% in recent months… Capital Markets

  5. Unusual returns • S&P 500 Annual Return • 1995: 37.6% • 1996: 23.0% • 1997: 33.4% • 1998: 28.6% • 1999: 21.9% Capital Markets

  6. Time In Market Capital Markets

  7. Implications • Correlation of risk and reward • To achieve above average returns, you must take risk • This can be done in an intelligent fashion!!! • Knowing your risk tolerance • Time horizon: how long until I need this money? • Diversification Capital Markets

  8. Time in Market • Investing for long-periods of time, likely you will have positive returns • Investing for long-period of time reduces risk. • Time in market, not timing market is your goal. • In the short-run, anything can happen Capital Markets

  9. Reducing Risk While Obtaining Returns • Diversify • Invest for long-term Capital Markets

  10. Forms of market efficiency • Strong: all information is reflected in stock prices • Including public and private information • No one can outperform the market • What about Martha? • Use of index funds • Diversification • Efficiency • Underperformance by investors • Average return large cap: • Average return large cap mutual fund: • Expenses: management fees/trading costs • Average return large cap mutual fund investor: • Buying last period’s top performer Capital Markets

  11. Forms of market efficiency • Semi-strong: all publicly available information is reflected in stock prices • Corporate financial analysis is a waste of time • Stock prices only react to “new” information differing from expectations • Questions: • Assumes intelligent investors? • Valid assumption? • Decline in inventory turnover ratio??? • Assumes rational investors? • Valid assumption? Capital Markets

  12. Forms of market efficiency • Weak: all prior stock price patterns reflected in stock prices • Technical analysis is a waste of time • Question… • January effect…anomaly?? • Sell losers, deduct losses up to $3,000 • Hold winners, pay not tax until you sell Capital Markets

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