Hi all, i am a bit confused about the specific calculation of risk adjusted return, for example, example 4 of reading 17, the calculation is stated as
U A
=E(Rm)−0.005 x RA x σ^2= E(RA )−0.01σ^2xA =10.0%−0.01(20%)^2 =10.0%−4.0%=6.0%
now, 20%^2 = 4%, times 0.01 it should be 0.04%, why is it still 4% in the calculation in BB?
I am not sure but seems you have common error with this one.
use E®-0.005 ( λ ) σ^2 if you use percentages or
use E®-0.5 ( λ ) σ^2 if you use decimal numbers.
Don’t do opposite 'cause the result would be as mentioned.
They already calculated the .005 x RA part, for ease of applying it to the three different standard deviations.
So .005 x 2 = .01 is the first step.
.01 x 20^2 = 4 is the second step. 10% - 4% = 6%
Notice here that 20%^2 = 400%, not 4%
Don’t get confused by the % signs. Since we are using .005 to adjust, just use whole numbers when you calculate and add the % sign to your result. If it’s easier for you to use decimals, then use .5 instead of .005 as Flashback mentioned above, but you have to stay consistent with the terms.
I prefer personally prefer the whole numbers. 10 - (.005 x 2 x 20^2) = 6
Viola!