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FIN 501 (31)
Chapter 1

Chapter 1 A Brief History of Risk and Return.docx

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Department
Finance
Course
FIN 501
Professor
Edward Blinder
Semester
Summer

Description
FIN501 investment analysis I CHAPTER 1 A BRIEF HISTORY OF RISK AND RETURN RETURNS  Returns on an investment have two components: 1. May receive some cash directly while you own the investment 2. Value of the asset you purchase may change  Total dollar return: return on investment measured in dollars that accounts for all cash flows and capital gains/losses TOTAL DOLLAR RETURN = DIVIDEND INCOME + CAPITAL GAIN (OR LOSS)  Dividend yield: annual stock dividend as a percentage of the initial stock price DIVIDEND YIELD = D t+1/ Pt  Capital gains yield: the change in stock price as a percentage of the initial stock price CAPITAL GAINS YIELD = (P t+1– Pt) / t  Total percent return: return on an investment measured as a percentage that accounts for all cash flows and capital gains or losses PERCENTAGE RETURN = DIVIDEND YIELD + CAPITAL GAINS YIELD AVERAGE RETURN  Average returns for investments do not reflect the impact of inflation  Risk-free rate: rate of return on a riskless investment  Risk premium: extra return on a risky asset over the risk-free rate; the reward for bearing risk RETURN VARIABILITY  Variance: common measure of volatility; measures the average squared difference between the actual returns and the average return o The bigger the number, the more the actual returns tend to differ from the average return 2 2 2 VAR(R) = [(R 1 R) + (R –2R) + ... + (R N R) ] / (N – 1)  Standard deviation (SD): square root of the variance EX. Calculating historical variance, particular investment has returns of 10%, 12%, 3%, -9% over the last four years.
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