Question

understand :

1.how to Calculate realized and expected rates of return and risk ?

2. Describe the historical pattern of financial market returns.

3.Compute geometric (or compound) and arithmetic average rates of return.

Explain the efficient market hypothesis and why it is important to stock prices

Answer 1

a

The realized return on the investment defines the actual holding return for the complete period achieved on holding the investments up to the maturity time .

· There should be no further capital outflows during the period

· All added positive benefits are reinvested in the portfolio of investment and only realized at the time to maturity .

Hence Realized return % = Final Redeem value / initial investment *100

Or

Realized return = Sell value obtained + Dividends received / Initial portfolio investment x100.

Expected rate of return .

This is the probabilistic rates of return on the overall portfolio based on the probability of occurrence of the particular state of the economy . As such they are calculated as a additive multiple of both the factors.

Let the following states of economy exists

No	Type of economy	Probability	Rate of return %
1	Boom	P1	R1
2	Flat	P2	R2
3	Recession	P3	R3

Hence Expected return % is calculated as

E(r) = P1*R1 + P2*R2   + P3*R3

Similar calculative principles are applied to risk where the Standard Deviation and Variance are used as a standard measure of risk .

2.

The historical patters of return of the financial markets have show cyclic patters of the return over the period of time , where the maximum returns were achieved on the periods of fast growing and booming economy and the downturn were seen during the depression phase in the economy .

As such on plotting the rate of changes in return , analysist have seen a cyclic pattern in the rate of returns historically in the financial markets,.

This patterns help to analyse the OverBought and OverSold regions of the market .

As history tends to repeat itself , analysts predicts their move based on the phase of the forecasted economy , when the markets are too ,high the correction is bound to happen and this repeats the cyclic pattern in the historical returns in the market

3.

In order to compute the geometric average return over a period of time , \

First we need to calculate the Holding period return of HPR of the particular period

Year	Returns
1	HPR 1
2	HPR 2
3	HPR 3

The HPR nothing but the total returns as a ratio of = (Ending Value / Begin Value) -1

Expressed as a percentage %

Hence the GM return is obtained as

= ( (1+HPR 1) X (1+HPR2) X(1+HPR3) )^1/n

Where n = is the number of years

Geometric return

Thanks