Risk and Return

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  • Created by: sian.s
  • Created on: 15-02-20 14:22
What is a risky investment
• A risky asset is one for which the (rate of) return that will be realized in the future is not known with certainty. = known as a risky investment
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In finance how is risk defined
risk is defined as uncertainty; whenever the outcome is uncertain, we have risk. Risk is measured by good and bad outcomes, so it is a mix of danger and opportunity.
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How many types of investors are there
3, Behaviour characteristics of individuals who want to invest How their utility of taking the risk is seen by them.
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What is risk loving
an investor who is willing to take on additional risk for an investment that has a relatively low additional expected return in exchange for that risk.
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What is risk averse
an investor who, when facing with two investments with a similar expected return, prefers the one with the lower risk.
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What is risk netural
an investor who is indifferent to risk but only consider the expected return when making an investment decision.
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What relationship is there between risk and return
• The higher the risk, the higher the required rate of return, and possible/expected return The rate of return that investors require for an investment depends on the risk associated with that investment, greater risk greater rate of return demanded
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What is the rate of return
The rate of return that investors require for an investment depends on the risk associated with that investment, greater risk greater rate of return remanded as compensation for bearing that risk
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Because of the risk and return relationship what do we do for finance decisions
• Need to find optimal combination of risk and return for finance decision How to get the best trade off between risk and return The optimal combo will be highest return for lowest risk
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What is expected return
is the estimated or predicted return before the outcome is known
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What is realized return
calculated after the outcome is known (ex post)
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What is holding period return
= the total return on an asset over a specific period of time • The total holding period return (R_T) consists of capital appreciation (R_CA) and income (R_i) (i.e. cash inflows during the holding period)
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what is expected return
an average of the possible returns where each return is weighted by the probability that it will occur • The expected returns is the weighted average of the possible investment returns, i.e. the sum of each possible return multiplied by the probabili
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what is expected value
= sum of the products of the possible outcomes and the probabilities of those outcomes being realised = (Ps x Bs) + (Pns x Bns)
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What is the caluclation for expected return
(Ri x Pi)
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what are the basic measures of risk
• Variance and standard deviation are basic measure of risk • Risk is the deviation from expected outcome. Standard deviation = square root of variance
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what does nomal distribution mean
Normal distribution means a symmetric frequency distribution that is completely described by its mean (average) and standard deviation also known as a bell curve due to its shape
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what is a useful tool for comparing risk and return for INDIVIDUAL financial investmenets
coefficient of variation (CV):
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what is the historical market performance for risky securties
• On average, annual returns have been higher for riskier securities
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what is the historical market performance for small stocks
• Small stocks have the largest standard deviation of returns and the largest average return
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what is the historical market performance for treasury bills
Treasury bills have the smallest standard deviation and the smallest average return
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Card 2

Front

In finance how is risk defined

Back

risk is defined as uncertainty; whenever the outcome is uncertain, we have risk. Risk is measured by good and bad outcomes, so it is a mix of danger and opportunity.

Card 3

Front

How many types of investors are there

Back

Preview of the front of card 3

Card 4

Front

What is risk loving

Back

Preview of the front of card 4

Card 5

Front

What is risk averse

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