How finance works
Risk and return
Measure what an investment earned and how risky it was, and see why riskier assets must promise more.
20 minfoundationMembers
Learning objectives
- Calculate a holding-period return including income such as dividends
- Measure average return and risk (standard deviation) from a history of returns
- Explain why riskier assets must offer higher expected returns, and calculate a risk premium
Every investment is a trade: you give up money today for an uncertain amount later. Two numbers summarise that trade: how much you expect to earn (return) and how uncertain the outcome is (risk).
Banks price loans with them, fund managers are judged on them, and companies use them to set the minimum return a project must clear. Every later track, from discounting to valuation, assumes you can measure both.
HPR = (P₁ − P₀ + D) ÷ P₀
- P₀
- price paid at the start
- P₁
- price (or value) at the end
- D
- income received while you held it: dividends, interest, rent
Included with a Formula Quest membership
The rest of this lesson is for members. Members get the full lesson, including its 3 graded exercises, and every other Finance Quest lesson.