Risk is typically defined as

the possibility of incurring harm

what is ex poste

past or historical returns

what is ex ante

future or expected returns

what does a return on investment consist of

two components 1. income yield 2. capital gain

what is income yield

is the return earned in the form of a periodic cash flow received by the investors - the interest payments from bonds and - the dividends from equities

what is the formula to calculate the income yield

Expected cash flows to be received / the purchase price CF/P

What is the yield to maturity

is the return earned by buying a bond and holding it to maturity - it is also an expected return over that very long investment horizon

What is the dividend yield

the cash that investors can expect to earn if the dividend payments over the next year are the same as they were over the previous period

what is the formula for the dividend yield

current dividend payments / the current value of the index - it is not a forecast of future dividends

what is a capital gain

the appreciation in price of an asset form some starting price, usually the purchase price or the price at the start of the year

what is a capital loss

the depreciation in the price of an asset from some starting price, usually the purchase price or the price at the start of the year

what is the formula for the capital gain (Loss) return or Yield

P1 - P0 / P0 (p I s the selling price or market price)

true of false common shares should gain with inflation (capital gain_ over the long run as their prices and cash flows are not fixed

true

the yield gap will increase or decrease with inflation

increase

how do you get the complete picture of the return form investing in bonds versus common shares

use the total return equation

what is the total return equation

income yield + capital gain (loss) yield

Estimate the income yield, capital gain (or loss0 yield, and total return for the following securities of over the past year a. a $1,000 par value, 6% bond that was purchased one year ago for $990 and is currently selling for $995 b. A stock that was purchased for $20, provided 4 quarterly dividends of $0.25 each, is currently worth $19.50

CF = 0.6 x $1,000 = $60 P0 = $990 P1 = 995 Income yield = 60/990 =6.06% Capital gain return = (995 -990)/990 = .51% total return = 6.06% + .51% = 6.57% or total return = (60 + 995-990) / 990 = 6.57% b. CF = 0.25x 4 = $1.00 P0 = $20 P1 = 19.50 Income yield = 1/20 = 5% Capital gain (loss) return = (19.50 -20)/20 = -2.5% Total return = 5% - 2.5% = 2.5% or (1+19.50 -20) / 20 = 2.5%

what are paper losses

capital losses that people do not accept as losses until they actually sell and realize them

what is a day trader

someone who buys and sells based on intraday price movements

what is mark to market

carrying securities at the current market value regardless of whether they are sold

how do you measure ex post or historical returns

use arithmetic mean or geometric mean

how do you calculate the arithmetic mean

add them all up and divide by how many (regular average)

how do you calculate the geometric mean

add 1 to each number, multiply all the numbers together, then to the exponent of 1/n, -1

which mean will be less the geometric mean or the arithmetic mean

geometric mean will always be less unless all the values are identical

the more the returns vary, the (bigger or lesser) the difference between the Am and GM will be

bigger the difference b/w the Am and GM

what is standard deviation definition

a measure of risk over all the observations; the square root of the variance

what is standard deviation in other terms

movement away from the mean (avg)

the larger the standard deviation the__________ _________ the return

more variable the return

when the standard deviation is squared, we get a measure called

the variance

the difference b/w Am and GM returns is approximately

half the variance