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Compute the historical average (that represents the expected return) and standard deviation of the 60 monthly observations of return on the Target stock (TGT) under
- Compute the historical average (that represents the expected return) and standard deviation of the 60 monthly observations of return on the Target stock (TGT) under analysis.
- Compute the historical average (that represents the expected return) of the 60 monthly observations of return on SHY.
- Compute its Sharpe ratio. For example, for Microsoft, its Sharpe ratio is the difference between the historical average of MSFT returns and the historical average of SHY returns, divided by MSFT standard deviation.
- For example, if the average monthly return of MSFT is 1%, the average monthly return of SHY is 0.25%, and the standard deviation of MSFT monthly return is 7.50%, then the monthly MSFT Sharpe ratio is (1%0.25%)/7.50% = 0.10.
- Conventionally risk and return measures, as well as Sharpe ratios, are annualized. To annualize the risk and return measures, scale expected returns by multiplying by 12, and standard deviations and Sharpe ratios by multiplying by (approximately 3.464).
- Following the above-mentioned example, the annualized expected return of MSFT is 12 1% = 12%, the annualized standard deviation of MSFT is 7.50% = 25.98%, and the annualized Sharpe ratio of MSFT is 0.10 = 0.3464.
- Repeat the above procedure and estimate the expected return, the standard deviation, and the Sharpe ratio of the market index (SPY).
- Hint: Yahoo! Finance reports the standard deviation of SPY in the Risk section of SPY page. Your SPY standard deviation estimate should be close to theirs.
- Report the annualized expected returns, the standard deviations, and the Sharpe ratio of the Target stock (TGT) under analysis.
- Report the annualized expected returns, the standard deviations, and the Sharpe ratio of the market index (i.e., SPY).
- Discuss and interpret your risk/return metrics.
- What do these risk/return metrics, including expected return, standard deviation, and Sharpe ratio, represent?
- Does the stock under analysis have higher expected return than the market index? How about the risk? The Sharpe ratio?
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