Risk and Return

Question 1

What is the equation for Monetary returns (given P and Div)?

Answer 1

P(t+1)-P(t)+Div(t+1)

or

P(t)-P(t-1)+Div(t)

Question 2

What is the equation for percentage returns?

Answer 2

(P(t+1)-P(t)+Div(t+1))/P(t)

Question 3

How do we calculate Expected Return (no probabilities)?

Answer 3

It’s the mean of all returns

Question 4

How do we calculate variance (no probabilities)?

Answer 4

Var=1/T-1[(r₁-r^)²+(r₂-r^)²+….]

Question 5

How do we calculate expected return given probabilities?

Answer 5

E(r)=∑(p(i)r(i) + p(j)r(j)….)

Question 6

How do we calculate variance given probabilities?

Answer 6

Var=P₁*(r₁-r^)² + P₂(r₂-r^)²….

REMEMBER TO SQUARE THE DIFFERENCES OF THE OBSERVED AND EXPECTED VALUES

Question 7

How do we calculate Covariance?

Answer 7

Cov(r₁,r₂)=∑[p(e)[r₁(e)-r^][r₂(e)-r^]+….]

where

p(e) is the probability of economic state, e, occurring

r₁(e) is the return of stock 1 in economic state, e

r₂(e) is the return of stock 2 in economic state, e

Question 8

How do we calculate correlation?

Answer 8

corr(r₁,r₂)=Cov(r₁,r₂)/σ₁σ₂

Question 9

How do we reduce risk?

Answer 9

Through portfolio diversification

Question 10

What is more concerning, systematic or firm specific risk?

Answer 10

Systematic because we cannot influence it, but firm specific risk can be minimised