Capital Market Course 5. V. Return and Risk The initial investment is 100 m.u., the value increase and we will obtain 130 m.u.  we earn 30 m.u.  Return.

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Presentation transcript:

Capital Market Course 5

V. Return and Risk The initial investment is 100 m.u., the value increase and we will obtain 130 m.u.  we earn 30 m.u.  Return rate: the earning from the investment for a time period, calculated as a percentage

V. Return and Risk ! Attention to the holding period, additional investments and additional incomes If we will obtain dividends of 10 m.u.  holding period return (HPR)  !Annual computation is a must: If an additional investment of 10 m.u. was made, then HPR  ¤ if the additional investment was made at the end of holding period, then HPR 

V. Return and Risk HPR – useful if the price only increase or only decrease; it is not according to the reality If the asset have a price of 100, after a year became 130 and at the end of second year worth again 100  for the first year HPR = and for the second year HPR ; the average is 3,46% Arithmetic Average: R = Geometric Average: R = for our example 0%

V. Return and Risk Suppose you buy an asset for 99 and you will sell it after a month for 100

V. Return and Risk Uncertainty regarding to the future market price  uncertainty regarding HPR  scenarios Scenarios: made by each investor Probability between 0 and 1 If the scenarios number increase: uncertainty increase Risk: the volatility on the returns of a financial instrument and the uncertainty related to the futures results generated by the volatility Market evolutionProbabilityShare PriceHPR Boom25%13030% Normal50%11010% Recession25%80-20%

V. Return and Risk Indicators: - variance: - standard deviation: - coefficient of variation: - Share A have the standard deviation of 5% and share B of 6%, expected return is 10% for A and 15% for B  coefficient of variation is 0,5 and 0,4

V. Return and Risk Investment in securities = postponing for current consumption  a return is needed If there is no uncertainty  risk free return  time value of money Risk Free Return Rate: influenced by: - real risk free rate - market characteristics - inflation Risk premium Risk: - business - financial - liquidity - exchange rate - country

V. Return and Risk Relationship between risk and return: direct The line that reflects the combination of risk and return available on alternative investments is referred to as the security market line (SML) Movements: - along the line - changes in the slope - shifts

Bibliography Bodie, Z., A. Kane, and A. J. Marcus (2007): Essentials of Investments, 6th edition, McGraw Hill International Edition Reilly, F., and K. Brown (2006): Investments Analysis and Portfolio Management, 8th edition, South-Western, Div of Thomson Learning; International Ed.