Portfolio-A collection, or group, of assets.

Risk-A measure of the uncertainty surrounding the return that an investment will earn or, more formally, the
variability of returns associated with a given asset.

total rate of return- The total gain or loss experienced on an investment over a given period of time;
FORMULA:

Where:
rt = actual, expected, or required rate of return during period t
Pt-1 = price (value) of asset at time t – 1(Beginning of the year)
Pt = price (value) of asset at time t (end of the year)
t - 1 to t
Ct = cash (flow) received from the asset investment in the time period

HOW INVESTORS RESPOND TO RISK

1. RISK AVERSION- The attitude toward risk in which investors would require an increased return as
compensation for an increase in risk. PREFERS LESS RISKY INVESTMENTS

-“a risk-averse investor will not make the riskier investment unless it offers a higher expected return
to compensate the investor for bearing the additional risk.”

2. RISK NEUTRAL- The attitude toward risk in which investors choose the investment with the higher
return regardless of its risk.

3. RISK-SEEKING- The attitude toward risk in which investors prefer investments with greater risk even if
they have lower expected returns.

SCENERIO ANALYSIS - An approach for assessing risk that uses several possible alternative outcomes (scenarios)
to obtain a sense of the variability among returns.
1. PESSIMISTIC
2. MOST LIKELY
3. OPTIMISTIC

RANGE FORMULA: OPTIMISTIC RETURN RATE – PESSIMISTIC RETURN RATE

RULE: The greater the range, the more variability, or risk, the asset is said to have.

PROBABILITY: Chance that a given outcome will occur

PROBABILITY DISTRIBUTION: A model that relates probabilities to the associated outcomes.

EXAMPLE:
BAR CHART: The simplest type of probability distribution; shows only a limited number of outcomes and
associated probabilities for a given event.
CONTINUOUOS PROBABILITY DISTRIBUTION: A probability distribution showing all the possible outcomes
and associated probabilities for a given event.

STANDARD DEVIATION: The most common statistical indicator of an asset’s risk; it measures the dispersion
around the expected value.

EXPECTED RETURN FORMULA:

 Probability X Rate of return =
Weighted value
 Weighted Value of
n = number of outcomes considered
Pessimistic, optimistic and
Prj = probability of occurrence of the jth outcome
rj = return for the jth outcome (Expected return) Most Likely = Expected rate of
return
STANDARD DEVIATION FORMULA

EXAMPLE:

RULE: the higher the standard deviation, the greater the risk.

COEFFICIENT OF VARIATION: A measure of relative dispersion that is useful in comparing the risks of assets with
differing expected returns.
FORMULA:

RULE: A higher coefficient of variation means that an investment has more volatility relative to its expected return.