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Investment Analysis Bus350 Return and Risk Calculation. Professor Tao Wang Tel: x5445 E-mail: tao_wang@qc.edu Room: PH154 Office Hour: W, F 12:15pm – 1:15pm Coursepage: http://www.qc.edu/~twang/course/350/investments.html . Announcements, homework, cases, exam dates are all on the webpage.

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Investment Analysis Bus350 Return and Risk Calculation


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Presentation Transcript
slide2
Professor Tao Wang
  • Tel: x5445
  • E-mail: tao_wang@qc.edu
  • Room: PH154
  • Office Hour: W, F 12:15pm – 1:15pm
  • Coursepage: http://www.qc.edu/~twang/course/350/investments.html. Announcements, homework, cases, exam dates are all on the webpage.
course overview
Course Overview
  • Book: Investment Analysis and Portfolio Management by Reilly and Brown
  • CFA-designated Textbook
  • Group case (10%), three homework (5%), two midterms (50%) and one final (30%). Class participation is 5%.
contents
Contents
  • Calculate return and risk based on distribution for a single asset
  • Calculate return and risk for a portfolio of assets
  • Holding Period Return
  • Real life indices
  • Calculate return and risk from index example, geometric mean and arithmetic mean comparison
probability distributions of returns
Probability Distributions of Returns
  • Assume that there are two stock available, GENCO and RISCO, and each responds to the state of the economy according to the following table
slide7

Probability Distributions of Returns of GENCO and RISCO

0.6

0.5

0.4

Probability

0.3

0.2

0.1

0

GENCO

50%

30%

RISCO

10%

-10%

-30%

Return

observation
Observation
  • Both companies have the same expected return, but there is considerably more risk associated with RISCO
observation1
Observation
  • The expected returns of GENCO and RISCO happen to be equal, but the volatility, or standard deviation, of RISCO is twice that of GENCO’s
  • Which stock would a typical investor prefer
example
Example
  • Calculate the expected return and standard deviation of the following stock A:

State Probability Return

1 20% 15%

2 60% 10%

3 20% -8%

The mean is 0.2*0.15+0.6*0.1+0.2*(-0.08) = 7.4%

The standard deviation is:

S.D. = Sqrt[0.2*(0.15-0.074)^2+0.6*(0.1-0.074)^2+0.2*(-0.08-0.074)^2] = 7.9%

portfolio return and risk
Portfolio Return and Risk
  • Suppose you invest in two assets: stocks and bonds.
  • Stocks offer a return of 10% with standard deviation of 15%
  • Bonds offer a return of 6% with standard deviation of 8%
portfolio weight
Portfolio weight
  • If the investment weight on stocks is 50%, on bonds is 50%, what’s the return on the portfolio?
  • What about the risk of the portfolio?
slide18
Arithmetic mean is used for forecasting future returns
  • Geometric mean is used to calculate real past returns
  • Geometric mean has upward bias
measure volatility
Measure volatility
  • Historical volatility
    • Standard deviation
    • Realized volatility
  • Future volatility
stylized facts
Stylized facts
  • Stock/Bond returns are fairly difficult to predict
  • But return volatilities are predictable to a degree
yahoo finance
Yahoo finance
  • Most indices historical data can be downloaded from http://finance.yahoo.com