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Fin501 notes.docx

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Ryerson University
FIN 501
Steve Joyce

Chapter 1Risk and return ReturnsDollar returns the gainloss from an investment is your returns on your investment o May be received in cash directly o The value of the asset may change capital gaino Total dollar return the return on an investment measured in dollars that accounts for all cash flows and capital gainslosses Percentage returns how much do we get for each dollar we invest Price of the stock at beginning of the yearThe dividend paid on the stock during the yearo Dividend Yield the annual stock dividend as a percentage of the initial stock price o Capital gains yield the change in stock price as a percentage of the initial stock price o Total percent return the return on an investment measured as a percentage that accounts for all cash flows and capital gains or lossesHistorical records Three important categories of financial investments o Large company stocks o Inflation data through CPI consumer o Canadian Treasury Bills price indexTotal market capitalization market cap equal to its stock price multiplied by the number of shares of stocko The value of the companys stock o Large companieslarge cap stocks o Small companiessmall cap stocks Average returns Risk premiums o Risk free rate the rate of return on a riskless investment o Risk premium the extra return on a risky asset over the riskfree rate the reward for bearing riskThe difference between risk free stock and risky return stockRisky assets earn a risk premiumThere is a reward for bearing more risk Return variability Variance common measure of volatilityWith equalWith unequalprobable outcomes probable outcomeso Standard deviation the square root of the varianceNormal distributiona symmetric bellshaped frequency distribution that is completely defined by its average and standard deviation Average returnsGeometric averagethe average compound return earned per year over a multiyear period o What you actually earned per year on average compounded annuallyArithmetic average return the return earned in an average year over a multiyear period o What you earned in a typical year Annualizing returnso Effective annual return EAR the return on an investment expressed on a peryear or annualized basis Chapter 2Diversification and asset allocation Expected returns Expected return ERaverage return on a risky asset expected in the futurePortfolios Portfolio group of assets such as stocks and bonds held by an investorPortfolio weights percentage of a portfolios total value invested in a particular assetCalculating the varianceAssumptions of Risk and Return for securitiesRisk uncertainty about future outcomes measured with variance or standard deviationReturn The expected returnExanti forward looking returno Determined by using the expost historical returnsAssumptions when measuring risk and returns o Asset returns are normally distributed o Investors have a quadratic utility functionUltimately we assume that for a given level of risk investors want to maximize return But for a given level of return they want to minimize risk Diversification and portfolio risk The principles of diversification spreading an investment across a number of assets will eliminate some but not all of the risk o Law of diminishing returns begins around 3050 randomly invested stocks That would be the area investors should aim for when diversifying their portfolio o Nondiversifiable risk systematic risk a certain level of risk that cannot be eliminated by diversifyingNave diversification o Randomly picking stocks so as to spread the risk out o Not optimal but it does mitigate the risk of putting all eggs in one basketEfficient diversification o Take a universe of n different risky assets
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