What are your estimated expected return and volatility over the next year to your investment in ABC stock?
The correct answer and explanation is:
To estimate the expected return and volatility of an investment in ABC stock over the next year, you would typically use historical data and financial metrics to make projections. Here’s a general approach for calculating these figures:
Expected Return
The expected return of ABC stock is the average return that an investor expects to earn over a certain period, typically a year. To calculate this, you can use the stock’s historical returns as a reference.
One common method is the arithmetic mean of the past returns, assuming the historical returns are a good predictor of future performance. If you have access to the stock’s annual returns over the past several years, you can calculate the average annual return as follows: Expected Return=R1+R2+⋯+Rnn\text{Expected Return} = \frac{R_1 + R_2 + \dots + R_n}{n}
Where:
- R1,R2,…,RnR_1, R_2, \dots, R_n are the historical annual returns.
- nn is the number of years used in the calculation.
Alternatively, you could look at analyst projections or use more advanced models like the Capital Asset Pricing Model (CAPM), which considers the stock’s risk relative to the market.
Volatility
Volatility measures the extent of price fluctuations of ABC stock over time and is a key indicator of risk. It is typically calculated using the standard deviation of the stock’s historical returns. The formula for calculating volatility (standard deviation) is: Volatility=∑(Ri−μ)2n−1\text{Volatility} = \sqrt{\frac{\sum (R_i – \mu)^2}{n – 1}}
Where:
- RiR_i represents each return for the period.
- μ\mu is the mean (average) return.
- nn is the number of data points.
If you have daily, weekly, or monthly returns for the stock, you can annualize the volatility by multiplying the standard deviation by the square root of the number of periods in a year (for daily data, multiply by 252\sqrt{252}, for monthly, multiply by 12\sqrt{12}).
Conclusion
To summarize, the expected return would be based on historical averages or analyst forecasts, and volatility would be derived from the standard deviation of the stock’s returns. However, these estimates are only projections, and actual returns may vary significantly due to unforeseen market conditions.