Investment Summary 1

Zhongyi Hu

Chapter Summary 1

Chapter one mainly talks about the historical relation between risk and return. The chapter also shows how risky certain investments can be and it gives you the tools to think about risk in an objective way. There are two key observations emerge from a study of financial market history. One is the reward for bearing risk, and another is that greater rewards are accompanied by greater risks.

To calculate the total dollar return, you need to use dividend income plus capital gain (or loss). The total dollar return on your investment is the sum of the dividend income and the capital gain or loss. If the investors want to know how much do they get for each dollar they invest, they need to calculate the percentage return. The total percentage return is using dividend yield plus capital gains yield. Here, the dividend yield means each dollar we invested we received how much in dividends. The capital gains yield means that for each dollar invested we got about how much in capital gains. Then we studied the record of financial market history. Different portfolios have different risks and returns. There are four main portfolios: small-company stocks, large-company stocks, long-tem U.S. government bonds, and U.S. Treasury bills. After taking a longer range look, we found that there has been a powerful financial incentive for long-term investing. Since the history of financial market returns in an undigested form is complicated, investors need to calculate average returns.

There are two methods to calculate average returns which are arithmetic average return and geometric average returns. The arithmetic average return is the return eared in an average year over a multiyear period and the geometric average return is the average compound return earned per year over a multiyear period. To combine these two averages, we use the Blume’s formula. It is common that investors make deposits or withdrawals through time. Thus, we need to use dollar-weighted...