Useful Investment Formulas:

 Relationship between real (r) and nominal (R) rates of interest:

= ≈ – [ is inflation]

 After-tax real rate of return (t is the tax rate):

(1 – ) – = ( + )(1 – ) – = (1 – ) – ( × )

 Total holding period return, rf (T), on a T -year treasury bond with $100 par value with
current price of P(T) is ( ) = ( )
–1

 Effective annual rate (EAR): = [1 + ( )] − 1

( )
 Annual percentage rate (APR): =
 Expected rate of return from the probability distribution of returns.
E(r) = ∑ ( ) ( ) [where p(s) is probability and r(s) is return in state s]
 Variance of returns from the probability distribution of returns. s2 = ∑ ( )[ ( ) − ( )]
 Expected return of a sample of returns. ( )= ̅=∑ ( ) ( )= ∑ ( )

 Variance of a sample of returns. s = ∑ [ ( ) − ̅]

 A typical investor utility function: = ( )− s

 Expected return on a portfolio of one risky asset and a risk-free asset (CAL):
E(rc) = yE(rp) + (1 – y) = + y[E(rp) – ]
 Variance of returns on a portfolio of one risky asset and a risk-free asset: s = s

 Sharp ratio of a portfolio of risky assets: SR =

s

 Optimal position of a risk-averse investor in the risky asset: y* =

s

 Expected rate of return on a portfolio: ( )=∑ ( )

 Variance of expected rate of return on a 2 asset portfolio of debt (D) and equity (E):
s = s + s +2 ( , )
s = ( , )+ ( , )+2 ( , )
( , )
and, since correlation coefficient = , s = s + s +2 s s
s s
 Minimum-variance portfolio of Debt (D) and Equity (E):
s s ( , )
w (D) = [when = −1]; and w (D) = ( )
[in other cases]
s s s s ,

 Optimum risky portfolio of D and E when there is no risk-free asset:

( ) ( ) (s s s )
wD =
(s s s s )

 Optimum risky portfolio of D and E when there is a risk-free asset:

( ) s ( ) ( , )
wD = ( ) ( ) ( ) ( )
s s ( , )
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 Optimal complete portfolio of D and E with a risk-free asset: y*=
s

 Regression equation of the single-index model:

= + + or = + + [ R = excess returns, r = total returns]
 Expected excess returns based on single-index model: ( ) = + ( )
 Components of risk as per the single-index model: = + ( )
 Covariance of returns as per the single-index model: ( , )=
 Correlation of returns as per the single-index model:

, = = = ( , ) × ( , )

 R2 of the single-index model: R2 = = ( )

 Risk premium of the market portfolio: ( )− = ̅ [ ̅ is average market risk

aversion]
 CAPM/SML relationship:
( )= + [ ( )− ]
( , )
( )= + [ ( )− ]

 Actually expected rate of return over a period: ( ) =

 Market risk premium: ( )= ̅
( )
 Beta of a security i: =
 Security market line: ( ) = + [ ( )− ]
 Factor model of security return: = ( )+ + + ⋯+ +
 Multifactor APT: ( ) = + ( )− + ( )− + ⋯+ [ ( )− ]
 Market model abnormal return: − ( + )
 Macaulay's duration: = ∑ ×
∆ ∆( )
 Duration and bond price risk: =− ×
∆ ∗
 Modified duration and bond price risk: =− ×∆
∆ ∗
 Bond price risk with convexity: =− ×∆ + × × (∆ )

 Duration of a perpetuity:

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