So time, value money calculations most people are, are familiar with.

So I do that just to start you off to you know to get you to remember the power of compounding. Most of the calculations that we're gonna do in terms of rates of return are gonna be based upon as we call asset return calculations and the idea is we have some investment so you think of buying a stock. We buy the stock, we buy the stock today at a given price, we hold it for some period of time, you know maybe four months and seven days and we sell it and we wanna know what's the rate of return on that investment right. And so associated with that we have something known as the holding period return. And then given a holding period return, we might want to slice and dice that holding period return to express it as an annualized rate of return or something like that. And so that's what we're gonna do now, in, in, in this part of the course. So, again the idea of a timeline is useful for acid return calculations. So the idea is today I have some asset I purchased for p0, so p0 is the price today. Of some asset. Now in this course we're primarily gonna be dealing with equity type assets, stocks, mutual funds, exchange traded funds, things like that. So you know, assets that are traded on exchanges, assets that we can get easy price information free from the internet, not have to pay some data subscriber and, and so on and so forth. We could be looking at futures contracts on commodities as another type of asset. Again, we can get information you know, pretty easily available and so on. We typically won't be looking at assets like investing in foreign currency or fixed income assets investing in particular bonds and things like that. The primary focus is really gonna be on equity-oriented types of assets. So, the easiest way to think about it is just investing in a stock. So here P0 is say is the price of some asset, let's say that's Starbuck stock. Okay? And then in at some time in the future, at time t, we're going to sell the asset at, for PT.

Right. And so this period between zero and T is our holding period. Right? That's the period of time that we actually physically own this asset. We, we, we, we hold on to it. And at the end of the holding period we sell it. And the rate of return. The percentage change in price over the holding period is the holding period return. So the holding period return. Is equal to the price we sell it for at the end of the holding period, minus the price we paid for it at the beginning of the holding period, divided by the price we paid for it at the beginning of the holding period, right? This is just the, percentage change in price over holding period. Okay, so let, so we talk about a holding period return, it's just percentage change in the price over a period of time that we hold the asset. Now very often holding periods are some standardized period like one month, or one year, and so on. In principle a holding period could be you know, six days, seven hours and twenty minutes and six seconds, right. But for our purposes we're going to consider pretty regular holding periods. Typically one month is going to be our default holding period for analysis. Sometimes it'll be a day, sometimes it'll be a year, but we're not gonna consider weird holding periods, like two one-half days, or something like that. That's mostly just for convenience. And the homework problems, you know, will deal with issues when you have irregular holding periods. How do you adjust some of the calculations and things like that. But from the point of view of the lectures it's gonna be pretty simple. So the default holding period for the notes and what's going to be going forward is gonna be one month, alright? And so the notation is going to be P of T is gonna be the price at the end of month T on an asset that doesn't pay any dividends. Okay, so think of a stock that doesn't pay a dividend. And PCT is the price at the end of the month. Here't' minus'1' is the price at the at

the end of the month'T' minus'1'. Okay, so this is the price at March twenty-fifth, this is the price on February twenty-ninth Okay. Then so my holding period is one month and so the month the rate of return is just the percentage change in price over the one month holding period. And so'RT' is one month return percentage change in price over one month. Now, we can write this percentage change in price, PT minus PT minus one divided by PT minus one. That's equal to PT divided by PT minus one, minus one. So we can rearrange this holding period return. So to find the net return or gross return, the net gross return so RT is PT, PT-1 divided by PT-1 and again you wanna think of your holding period from time T-1 to T, PT-1, PT and the return of the time struck T is the percentage change in price between T-1 and T. Now we can take this return, and write it as PT divided by PT minus one, minus PT minus one divided by PT minus one, which is. Pt divided by PT minus one minus one. So RT. Is equal to this. And then we can take this minus one to the other side, and write RT or one plus RT. Is equal to PT divided by PT minus. So one plus the rate of return is called the gross return and this is then just the ratio of prices. So you could also think of this as sort of, like, the future value of a dollar. If I have $one invested at T-1, how much does that $one grow, after one month? It's equal to $one + the interest rate on $one. One+RT. 'Kay? So. Now, one of the things about this class, that I, that I want to emphasize, and that is to get an idea of what are reasonable orders of magnitude of rates of return on different investments. Okay? So if you hold Microsoft stock for a month, how much on average, do you really expect to get on a one month investment in Microsoft? Is it ten%, is that reasonable, is it one%, is it 100%? And so we start looking at data, you know, pay attention to the orders of magnitudes

of things. And I think it's very important to have that in our mind, you know? What is a typical rate of return over a year on investment in, in equity, right? What's a typical rate of return over a month, right? And so, So, we'll illustrate this by example and also by looking at, at, at real data. So. This is an example, that's somewhat, Unrealistic. So we invest in Microsoft. Now it might have been realistic if you were back in 1990 and investing in Microsoft this might of happened. But it's not necessarily the case if you are investing in Microsoft now. So you pay, you initial buy Microsoft for 85 at the, at the end of the to previous month and you hold it for one month and the price goes up from $85 to $90. You get a, A $five increase in one month. Alright, so what's your monthly rate of return. Well, it's a percentage change in price over the month, and this gives us a, an, a rate return of 5., 88 percent. So that's a one month holding period, right? Now remember, right now if you invest in a U.S. Government T bill for one year, you get less than one percent for the year. This is illustrating getting five percent by investing in Microsoft over a month, right. Almost seems too good to be true and so this is quite unusual as a monthly investment. And so your one dollar it grows to return one+ and the net rate of return is 1.85. So, you started with a dollar and after one month you have a dollar five and 88 cents. So, it gives you 5.88 percent per month. Okay. Now, let's look at, multi-period, returns. Let's say our horizon is not one month, but we have a 2-month investment horizon, right? What is the rate of return over a 2-month investment horizon? So, now use this notation, R sub T (two). So, this means I have a 2-month rate of return. That's what, this notation means. What's the 2-month rate of return? Well, it's the percentage change in price

over two months. So, now the idea is. I have my investment horizon, here's T minus two, T minus one, and T. I buy it for PT minus two. I sell it for PT. What is my percentage change in price? So over the whole period, I have a two period return. Okay. Percentage change in price and then we can write this at pt divided by pt minus two minus one so one plus the two period return is the crisis. Now this, what can ask this question. What's the relationship between this two month return, and the two one month returns between T minus two and T? Right? So I want to know I have some return here, and I have another return here; and I have this two period return over the two whole periods. We can do this little trick. We know that the two period return is PT / PT -2-1. Now, we can take this PT / PT -two, and we can multiply and divide by PT-1. That gives us PT / PT-1. Pt-1 / PT-2. Now, PT / PT-1 is one+ the rate of return between periods T-1 and T. And PT-1 / PT-2 is one+ the rate of return between time periods T-2 and T-1. So notice that the two period return. Is. This is called a geometric average of two, one period returns. And then minus one. So notice this two period return is not the sum. Of two, one period returns. But it's a multiplicative. Relationship. So the relationship here, this is then equal to one+RT-1 times one+RT-1. Now. This is, okay. The, this is what it is. But as we'll find from modelling. From a modelling perspective. You know, we're gonna. Build probability models for asset returns. And one of the nice things about probability models that we'd like to have is a nice relationship between asset returns. Say over one month, and asset returns over two months or one year and things like

that. And we would like to say things like asset returns are normally distributed. Now, when you start having relationships that are multiplicative, that makes it very difficult, in, in modeling things, particularly with random variables. And so this, multiplicative relationship between a two month return and a one month returns, may cause some problems. And so I just wanna point that out, that this is a somewhat of an inconvenient relationship. All right, so to summarize, we have a 1-month gross return over month t, a 1-month gross return over month t minus one, and the 2-month gross return is the product of the two 1-month gross returns, 'kay? And if you look at this relationship so that the 2-month return when you multiply everything out here You know, so'1' plus'RT', 'one plus RT minus 1', so you get'1' and then'RT' and then sorry'RT minus 1' and'RT times RT minus 1', the 1's cancel over here so the two month return is the sum of the two one month returns plus this cross product return. And, now, if this cross product return is small, then the two month return is approximately the sum of the two one month returns. Okay, so it's almost additive, but not quite. And, so again, that's one thing to keep in mind. So we can do an example here. Just plug in some data. Two month return on Microsoft, so at the end we, we buy Microsoft at 80. Initially, and then, we sell it at 90 over this two month period. So now, over two months, Microsoft stock goes up by $ten over two months, so we get a two month return of twelve%, okay? That's, that's pretty darn good if you can get twelve percent over two months, And then what are the two one month returns, so remember in our previous example price between, in this month here at'T minus 1' was 85, so our rate of return between T minus 1' instead of between'T minus 2' and'T minus 1', we get six one-half percent over the first month and then over the second month we got 5.8 percent and so our one plus or two month return is the product of the two one month growth returns. Everything works out fine. Now, we can do the same thing if our

investment horizon's k months. So say our investment horizon is two years, 24 months. And so, what's the rate of return over two years? Well it's a percentage change in price over two years. And what's the, so this would be the two year gross return What's the relationship between the two year gross return and the 24 one month returns. Well it's this multiplicative relationship. This is called a geometric average. So the 24 month product return is the product of all these 24 one month returns, and again it's multiplicative is not additive and so the, we don't have this relationship here because of all the cross product returns. And as I said before, from the point of view of modeling asid returns this multiplicative relationship here makes things a bit cumbersome, and we would like to see if we can get around this in some