Week 6

Question 1

what is realised return

Answer 1

Return is profit or loss from investment, such as deposit, stock, bond and etc.
Dollar return: profit or loss from investment in terms of dollar amount
Dollar return = Dollar Income + Capital Gain

Realized return reflects history - but history can be useful to guide the future.

Question 2

what is capital gain

Answer 2

difference between selling and purchasing prices

Question 3

what is the expected return

Answer 3

Expected return, E(R): the rate of return expected to be realized from an investment over a long period of time.
It is the ‘expected value’ of possible ‘returns’ in the future.
In statistics, it is also referred as ‘mean given probability distribution’.
Expected return is also known as required (rate of) return.
‘Required (rate of) return’ is the minimum ‘Expected Return’ to satisfy investors

Question 4

1 standard deviation of the mean

Answer 4

68% of values are within

Question 5

2 standard deviations of the mean

Answer 5

95% of values are within

Question 6

99.7% of values are within

Answer 6

3 standard deviations of the mean

Question 7

explain risk return relationship

Answer 7

Risk aversion: rational human beings are unwilling to take risk, unless they are rewarded with sufficient incentive.
For risk-averse investors, ‘sufficient incentive’ means higher expected return.
Additional (expected) return is needed to compensate for taking additional risk.
The level of additional return, a.k.a. ‘risk premium’, depends on many factors.
Different investors have divergent level of risk aversion (appetite).
Aggressive vs. conservative
Same investor’s risk aversion is also time-varying.
Age, income level, family and etc.

There is a positive relationship between risk and expected return:
‘the greater the risk, the greater the expected return’
Investors accept higher risks because they can expect a higher return - this may or may not materialise, which is (investment) risk.