Investment Math

Holding Point Return

(Ending Price - Beginning Price + Cash Flows)/Beginning Price

Arithmetic Return means

to add the returns together

What does HPR measure

It measures returns for one asset over one holding period

Geometric Return means

to multiply the returns together

How is single Period Return Calculated

Using Holding Point Return

True or false Arithmetic return for multiple periods will be greater or higher than geometric return?

TRUE

Define the Required Rate of Return

Its the required return the investor needs to be compensated

Required Rate of Return Equation

Real Risk Free Rate+ Expected Inflation+Risk Premium

What is Risk premium

Extra Return investors need for taking on risk. More Risk→Higher Return

What is Disbursion of Returns/When is risk present?

Whenever the observed R(Returni) is different from the expected return

How is dispersion measured

Using Variance, Standard deviation and range

What is the ERi

the return you expect an investment to earn on average, based on the possible outcomes and their probabilities. its a weighted average prolixity

Expected Rate of Return Equation

E(ri)= {(Pi)(Ri) i

Coefficient of Variation Cvi Equation

oi/E(Ri)

What is the Coefficient of Variation?

It’s a measure of risk per unit of expected return. The lower the CV the better

Semi Variance

Calculates variance only below the expected return

Expected Return of a portfolio Formula

E(Rp)= {Wi(ERi))

Wi meaning

percentage of your money in asset i

Eri meaning

Expected Return of asset i

How is a portfolios risk measured?

Using covariance which is a measure of co-movement

Covariance

measures how two investments move together

Correlation Formula

(CovAB)/OaOb

Portfolio Risk depends on

• How much money you put in each investment

• The risk of each investment

• How the investments move relative to each other

Total Risk

Systemic+Unsystemic Risk

Non-Diversifiable+Diversifiable Risk

Market Risk+ Company Specific Risk

How is Total Risk Measured

Using Standard Deviation(NOT BETA)

TF Systemic Risk can be diversified away

FALSE Systemic Risk can’t be diversified away ex is a natural disaster

TF Unsystematic Risk can be diversified away

True example - one company has a major problem, owning many different companies reduces the effect on your overall portfolio.

How is systemic risk measured

using BETA

BETA

how sensitive an investment is to market movements

Beta>1

investment tends to move with the market at the same level of sensitivity

Beta<0

Investment tends to move opposite the market

Beta = 0

No systemic market sensitivity

Beta<0

Tends to move opposite of the market