Investment Math Flashcards
What 6 factors do you need to consider when making an investment decision?
1) Objective
2) Expected rate of return
3) Risk
4) Taxes
5) Horizon
6) Strategy
What 3 items make up investment strategy?
A) Selection
B) Timing
C) Diversification
Why is arithmetic mean not viable for multiple period investment math?
Because it is biased upwards when compared with the geometric mean.
How do you calculate holding period return?
HPR = (Ending Price – Beginning Price + Cash Flows) / Beginning Price
How do you calculate the arithmetic return?
Arithmetic Return = ∑ HPR
How do you calculate arithmetic mean return?
Arithmetic mean return = ∑ HPR / N
How do you calculate the geometric return?
Geometric Return = [ ∏ (1+HPR) ] – 1
How do you calculate the geometric mean return?
Geometric Mean Return = [ ∏ (1+HPR) ]^1/N – 1
How do you calculate the required rate of return?
Required Rate of Return = Real Risk Free Rate + Expected Inflation + Risk Premium
How do you calculate the nominal risk free rate?
Nominal Risk Free Rate = Real Risk Free Rate + Expected Inflation
How do you calculate the fisher effect?
Fisher Effect = (Real Risk Free Rate × Expected Inflation)
How to calculate the real rate of return?
Real Rate = [ 1 + Nominal Rate / 1 + Inflation Rate] – 1
How do you calculate the risk premium?
Risk Premium = ƒ { Business Risk + Financial Risk + Liquidity Risk + Default Risk +
Exchange Rate Risk + Country Risk)
How do you calculate the expected rate of return?
E(Ri) = ∑ (Pi)(Ri)
Pi is the probability of a particular state of nature Ri is the return for that particular state of nature.
How do you calculate variance?
Variance = σ^2 = ∑ (Pi)(Ri – E(Ri))^2
Where Pi = Probability
Ri = Return
E(Ri) = Expected Rerturn
