Question

Explain how the expected rate of return and the risk of an individual asset are measured.

Answer 1

The expected return is the amount of profit or loss an investor can anticipate receiving on an investment. An expected return is calculated by multiplying potential outcomes by the odds of them occurring and then totaling these results.The expected return is usually based on historical data and is therefore not guaranteed. This figure is merely a long-term weighted average of historical returns.

Expected Return = SUM (Returni x Probabilityi)

The degree to which all returns for a particular investment or asset deviate from the expected return of the investment is a measure of its risk.

. The extent of the deviation of investment returns is referred to as the volatility, which is, thus, measured by the standard deviation of the investment returns for a particular asset. Volatility differs according to the type of asset, such as stocks and bonds. Individual assets also differ in volatility, such as the stocks of different companies and bonds by different issuers. Volatility is commensurate with the investment's risk, and this risk can be quantified by calculating the standard deviation for particular investments, which is done by measuring the historical variation in the investment returns of particular assets or classes of assets. The greater the standard deviation, the greater the volatility, and, therefore, the greater the risk.