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Chapter 8

MGT338H5 Chapter 8: ch 8.docx

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Adam Kadar

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Chapter 8
Risk and Return
Risk free rate – at what return do you get real return + expected inflation rate regardless of what
Ex Ante  amount of money have to invest before you even begin game or anything happens: rate
of return expectation before something happens
Ex Post after the fact, stock performance has been x …. What has been rate of return on stock
Risk of earning bond income is less than earning dividend income. Bond holders = secured
creditors whereas dividends = declared, while company doesn’t always have to declare dividends
Yield Gap – look at the incoming yield on bond instead of incoming yield on stock
Income gap of bonds over stock on avg is decreasing over the last 40 years
Holding period return can be unrealistic if time is unrealistic (e.g. if earn 1000 in 3 days doesn’t
mean you will the similarily in 100 days)
Measuring avg returns
Ex post = after the fact
Arithmetic avg  simple avg  sum returns / # of periods
Geometric mean  more accurate assessment, seeing where you started and where you ended up
and what rate you need to get there  multiply returns over compound growth
Yr 1 + 10%
Yr 2 – 10%
Start with 100$
Arithmetic : mean + 10% + (-10%) = 0%
Geometric: [(1.1) (0.9)] ^ (1/2) – 1  this difference gets bigger the wider the spread is
Ex ante returns: no guarantee that what you think will happen, will happen
Historical avf rate of return not necessarily will be realized
Risk for investor = not earning what you expect to earn  anything to the left of normal
distribution curve
Way to quantify risk
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