Risk and Return

Question 1

What investment is considered a risk free security?

Answer 1

treasury bills
–> investment in three-month treasury bills

Question 2

Holding Period Return

Answer 2

• measures the total return over a specific period
• includes price appreciation and income (like dividends)
• expressed in percentage

–> HPR = capital gain (or loss) + dividend yield

Question 3

expected return

Answer 3

weighted average of possible returns, where the weight corresponds to the probabilities

E(r) = sum of p x r

Question 4

variance

Answer 4

the expected squared deviation from the mean

Var(r) = sum of p x (r - E(r))²

Question 5

standard deviation

Answer 5

square root of the variance, so that it is a percentage term

SD(r) = sqr(Var(r))

Question 6

interpreting the results from standard deviation

Answer 6

if things go extremely well, the stock will have a return of the expected return + standard deviation

if things go extremely bad, the stock will have a return of the expected return - standard deviation

Question 7

annual realized returns

Answer 7

if a stock pays dividends at the end of each quarter and they are immediately reinvested, you need to calculate the annual realized returns:
r1, r2, r3, r4 are the returns between the end of the quarter (including the dividend) and the price before that (use the HPR formula)

R = (1 + r1) x (1 + r2) x (1 + r3) x (1 + r4) - 1

Question 8

population vs sample approach

Answer 8

population: divide by n –> e.g. if you had all daily returns from a stock from the day it was listed, you could calculate the population variance; not estimating but describing a complete set of data

sample: divide by n-1 –> e.g. if you’re analyzing the stock using data from the last year (a subset of all possible returns), you would use the sample variance; sample from a larger population