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Investment Analysis Bus350 Return and Risk Calculation

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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  1. Investment Analysis Bus350Return and Risk Calculation

  2. 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.

  3. 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%.

  4. 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

  5. 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

  6. Returns on GENCO & RISCO

  7. 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

  8. Observation • Both companies have the same expected return, but there is considerably more risk associated with RISCO

  9. Equations: Mean

  10. Equations: Standard Deviation

  11. 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

  12. 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%

  13. 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%

  14. 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?

  15. Holding Period Return

  16. Measures of Historical Rates of Return

  17. Measures of Historical Rates of Return • Geometric Mean

  18. Arithmetic mean is used for forecasting future returns • Geometric mean is used to calculate real past returns • Geometric mean has upward bias

  19. Measure volatility • Historical volatility • Standard deviation • Realized volatility • Future volatility

  20. Stylized facts • Stock/Bond returns are fairly difficult to predict • But return volatilities are predictable to a degree

  21. Yahoo finance • Most indices historical data can be downloaded from http://finance.yahoo.com

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