Scribd
Upload
92 views

Computing Returns: Price Beginning Dividends Price Beginning - Price Ending Return +

The document discusses computing returns and risk. It defines return as the ending price minus the beginning price plus dividends, divided by the beginning price. It explains that percentage return is more useful than dollar return as it accounts for different investment amounts. Returns can be positive or negative, while risk refers to the uncertainty of future returns. Expected return captures the average return while variance and standard deviation are used to measure risk. Portfolio return is the weighted average of the individual asset returns, while portfolio risk depends on the variance of each asset and their covariances.

Uploaded by

Jitendu Dixit
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PDF, TXT or read online on Scribd
92 views

Computing Returns: Price Beginning Dividends Price Beginning - Price Ending Return +

The document discusses computing returns and risk. It defines return as the ending price minus the beginning price plus dividends, divided by the beginning price. It explains that percentage return is more useful than dollar return as it accounts for different investment amounts. Returns can be positive or negative, while risk refers to the uncertainty of future returns. Expected return captures the average return while variance and standard deviation are used to measure risk. Portfolio return is the weighted average of the individual asset returns, while portfolio risk depends on the variance of each asset and their covariances.

Uploaded by

Jitendu Dixit
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 5

Computing Returns

Return and Risk


Ending Price - Beginning Price + Dividends
Return =
Beginning Price

Percentage Return or Dollar


An Example Return?
„ You bought IBM stock at $40 last month. The „ It is more convenient to use the percentage
price of IBM stock is $45 today. IBM paid $1 return, or the rate of return.
dividend yesterday. What is your holding „ A $1,000 return is quite good for an initial
period return? investment of $1,000, but not so impressive if
the initial investment is $1 million.
„ Dollar return per share: $45-$40+$1=$6 „ A 10% return implies that if you invest $1000
„ Rate of return: $6 / $40 = 15% you would make $100 and if you invest $1
million you will make $100,000.

Percentage Return or Dollar


Return? 10% or 10?
„ So the rate of return presents the complete „ We like to express return in percentage
picture. terms. 10% is the same as 0.1 but not the
„ In this course, return means the rate of return. same as 10.
„ 0.01% is called a basis point.
„ Return is not unitless. We tend to annualize „ P = $1 / (10 - 5) = $0.20
returns. „ P = $1 / (10% - 5%) = $20
„ Returns are bounded below at -100%.

1
Averaging Returns Averaging Returns
„ Suppose you invested half of your money in X „ Suppose you invested all of your money in X
and half of your money in Y. „ The return of X is 100% last year and -50%
„ The return of X is 100% and the return of Y is this year.
-50%. „ What is your average return over the two
„ What is the average return? years?

Future Return is unknown Return and Risk


„ Under uncertainty, we measure “reward” by
P − P + Dt using the expected (or average) return.
Rt +1 = t +1 t
Pt „ We measure “risk” by using the variance of
returns
„ Investments are risky.
„ Pt+1 is not known at time t; hence Rt+1 is
not known at time t.
„ How do we capture the randomness of
Rt+1?

Expected Return and


Variance Sample Mean and Variance
N
1
N
µ X = E ( X ) = p1 X 1 + p2 X 2 + L + p N X N = ∑ pi X i
X=
N
∑X
i =1
i

i =1
2

∑ (X i − X )
1 N
Vaˆr ( X ) =
N
Var ( X ) = σ = ∑ pi [ X i − E ( X )]
2 2
X N − 1 i =1
i =1

2
Annualize Return Annualize Variance
„ There are two ways you can annualize
„ Variance is proportional to time
returns.
Annualized Variance = σ2 × T
„ Suppose R is the per period return and T is
the number of periods per year.
„ Standard deviation is proportional to the
square root of time
„ APR = R × T
Annualized Standard Deviation = σ × T0.5

„ EAR = ( 1 + R ) T - 1

Excess Returns Expected Return of A Portfolio


„ The raw return includes compensation for „ Adding more assets to a portfolio does
both the time value of money and the risk of not make the calculation of expected
the security. return more difficult.
„ An excess return or risk premium is the
compensation for risk bearing alone.
„ E(Rp) = w1E(R1) + w2E(R2) + … wnE(Rn)
Excess Return or Risk Premium = Ri − R f = Rie
„ This is the raw return less the risk-free rate.

Variance of A Portfolio More on Covariance


„ We are often interested in the variance of a „ Now consider the three asset case.
portfolio. If there are two assets in the
portfolio, Var(w1X + w2Y + w3Z) = w12Var(X) + w22Var(Y)
+w32Var(Z) + 2w1w2Cov(X,Y)+ 2w1w3Cov(X,Z)+
Var(w1X +w2 Y) = w12Var(X) + w22Var(Y) 2w2w3Cov(Y,Z)
+ 2w1w2Cov(X,Y)
„ The formula gets very complicated when
where Cov(X,Y)=Corr(X,Y)σ(X)σ(Y) there are many assets in the portfolio.

3
Matrix Notation Portfolio Return and Risk
„ R is a column vector of expected returns „ Using matrix notation for portfolio return and
„ W is a column vector of portfolio weights risk,
„ ∑ is the covariance matrix E (R p ) = w1 R1 + w2 R2 + ... + wn Rn = w′R
Var (R p ) = w12σ 12 + w22σ 22 + ... + wn2σ n2
„ Example:
⎡ 0.1 ⎤ ⎡0.4⎤ ⎡0.04 0.01 0.01 ⎤
+ 2w1w2σ 1, 2 + 2w1w3σ 1,3 + ...
R = ⎢⎢ 0.2 ⎥⎥ W = ⎢⎢0.3⎥⎥ Σ = ⎢⎢ 0.01 0.09 − 0.01⎥⎥
= w' Σw
⎢⎣0.15⎥⎦ ⎢⎣0.3⎥⎦ ⎢⎣ 0.01 − 0.01 0.04 ⎥⎦

Mean Standard Deviation

Excel Functions Excel Functions

4
Excel Functions Covariance

Correlation Data Analysis

Covariance Covariance Matrix

You might also like