Investment - current commitment of

dollars for a period of time in order to

derive future payments that will
compensate the investor for (1) the time
the funds are committed, (2) the expected
rate of inflation, and (3) the uncertainty of
the future payments.

A. Arithmetic Mean (AM) sum

of annual HPYs is divided by the number of
years (n)
-

Why people invest to earn a return

from savings due to their deferred
consumption. required rate of return
Measures of Historical Rates of
Return
1. Holding period return (HPR)

good indication of the expected

rate of return for an investment
during a future individual year
biased if you are attempting to
measure an assets long-term
performance

B. Geometric Mean (GM) - nth

root of the product of the HPRs for n years
-

superior measure of the long-term

mean rate of return because it
indicates the compound annual rate of
return

<1 = Positive Return

>1 = Negative Return
0 = You lost all your money
Holding period - period during
which you own an investment
2. Holding period yield (HPY).
- percentage terms on an annual
basis
- assumes a constant annual yield
for each year

3.2 For A Portfolio of Investments:

1. Weighted average of the HPYs for the
individual investments in the portfolio
(dollar-weighted or value-weighted mean
rate of return.)
2. Overall change in value of the original
portfolio (as is)

* To derive an annual HPY, you compute

an annual HPR and subtract 1. Annual HPR
is found by:

3. Mean Rates of Return

- Summary figure that indicates
this investments typical experience, or
the rate of return you should expect to
receive if you owned this investment over
an extended period of time

Expected Rate Of Return - how certain

the expected rate of return on an
investment is by analyzing estimates of
expected returns
RISK - uncertainty that an investment will
earn its expected rate of return
1. Expected Return

3.1 For Single Investment:

`

3.1 For Risk-Free

- Probability of return is = 1

A
M
3.2 For Uncertain

Measuring the Risk of Expected Rates

of Return
. 1. Variance - larger the variance for an
expected rate of return, the greater the
dispersion of expected returns and the
greater the uncertainty, or risk, of the
investment

For Historical Rates of Return:

When all outcomes are known and

their related probabilities are
assumed equal:

2. Standard Deviation The most

common statistical indicator of an assets risk;
it measures the dispersion around the
expected value.

higher the standard deviation, the

greater the risk.

3. Coefficient of variation A measure

of relative dispersion that is useful in
comparing the risks of assets with
differing expected returns.

Real Risk-Free Rate (RRFR) - basic

interest rate, required return on a risk-free
asset

Risk Premium (RP) - increase in the

required rate of return over the NRFR
Systematic Risk - relevant portion of an

assets risk attributable to market factors that

affect all firms; cannot be eliminated through
diversification

Unsystematic Risk - portion of an assets

Nominal Risk-Free Rate (NRFR) - The
actual rate of interest charged by the
supplier of funds and paid by the
Inflation Premium
demander.

risk that is attributable to firm-specific, random

causes; can be eliminated through
diversification.