Expected Rate of Return Discussion

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The expected rate of return is a measure of the average gain or loss an investor can anticipate from holding a security over a certain period. A higher expected rate of return generally indicates a more attractive investment opportunity, as it suggests the potential for greater profits. The standard deviation of the rate of return measures the volatility or risk associated with an investment. A higher standard deviation indicates greater price fluctuations, implying higher risk. On the other hand, a lower standard deviation suggests more stable and predictable returns. The coefficient of variation is a relative measure of risk-adjusted return and is calculated by dividing the standard deviation by the expected rate of return. Lower CV indicates better risk-adjusted performance

Forming a portfolio that involves different securities or assets to achieve specific investment objectives. One of the important benefits of portfolio formation is risk diversification. Risk diversification involves investing in a mix of assets that are not perfectly correlated. Because the impact of poor performance in one asset can be offset by better performance in another.

The expected rate of return, standard deviation of rate of return, and coefficient of variation are crucial criteria for assessing the performance of a security. Portfolio formation allows for risk diversification, leading to a reduction in risk and potentially improved properties compared to individual constituents.

Reference
Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2022). Fundamentals of corporate finance (13th ed.). McGraw-Hill