The annual returns of a stock and the risk-free interest rate are given as follows: Year 2010 2011 2012 2013 2014 Stock Return % 5% -9% 6% 15% Rf 2% 1% 2% 0.5% 1% Calculate the arithmetic average stock return. 7+5+-9+6+15= 17/5= 3.4 Calculate the geometric average stock return. G=[(1+7%)(1+5%)(1+-9%)(1+6%)(1+15%)]^1/5-1 = 1.246387^1/5-1=4.5% Calculate the standard deviation of stock returns (could be done by Excel). Calculate the risk premium of the stock. Calculate the standard deviation of the excess returns. Calculate the Sharpe ratio of the stock.
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
The annual returns of a stock and the risk-free interest rate are given as follows: Year 2010 2011 2012 2013 2014 Stock Return % 5% -9% 6% 15% Rf 2% 1% 2% 0.5% 1% Calculate the arithmetic average stock return. 7+5+-9+6+15= 17/5= 3.4 Calculate the geometric average stock return. G=[(1+7%)(1+5%)(1+-9%)(1+6%)(1+15%)]^1/5-1 = 1.246387^1/5-1=4.5% Calculate the standard deviation of stock returns (could be done by Excel). Calculate the risk premium of the stock. Calculate the standard deviation of the excess returns. Calculate the Sharpe ratio of the stock.
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