Lec 4. CH 11. Return and Risk
1. Individual Securities
- Expected return: The return that an individual expects a stock to earn over the next period. Only and expectation. An individual's expectation may simply be the average return per period a security has earned in the past.
- Variance and standard deviation: The volatility of a security's return.
- Covariance and correlation: Returns on individual securities are relate to one another. The relationship between two securities.
*Note!!! Correlation is a translated version of covariance. The two parameters always have the same sign (positive, negative, or 0)
2. Expected Return, Variance, and Covariance and Correlation
| Stock Fund | Bond Fund | ||
Scenario | Rate of Return | Squared Deviation | Rate of Return | Squared Deviation |
Recession | -7% | 0.0324 | 17% | 0.0100 |
Normal | 12% | 0.0001 | 7% | 0.0000 |
Boom | 28% | 0.0289 | -3% | 0.0100 |
Expected return | 11.00% |
| 7.00% |
|
Variance | 0.0205 |
| 0.0067 |
|
Standard Deviation | 14.3% |
|
|
|
Scenario | Stock Deviation | Bond Deviation | Product of Deviation |
| | | |
Recession | -.18 | .10 | -.0180 |
Normal | 0.1 | 0 | .0000 |
Boom | .17 | -.10 | -.0170 |
Sum |
|
| -.035 |
Covariance |
|
| -.0117 |
Correlation
=> Strong negative