Chapter 4 Risk and Return-Part 2.

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Presentation transcript:

Chapter 4 Risk and Return-Part 2

Return Calculation Example The stock price for Stock A was $10 per share 1 year ago. The stock is currently trading at $9.50 per share and shareholders just received a $1 dividend. What return was earned over the past year? $1.00 + ($9.50 - $10.00 ) = 5% R = $10.00

The stock price for Stock A was $10 per share 1 year ago The stock price for Stock A was $10 per share 1 year ago. The stock is currently trading at $9.50 per share and shareholders just received a $1 dividend. What return was earned over the past year?

Return Measurement for a Single Asset: Expected Return Copyright © 2006 Pearson Addison-Wesley. All rights reserved.

Risk Measurement Risk of an asset can be measured using statistics. (1) Standard deviation (2) Coefficient of variation Standard deviation-The most common statistical indicator of an asset’s risk. It measures the dispersion around the expected value.

Risk Measurement for a Single Asset: Standard Deviation The expression for the standard deviation of returns, k, is given in Equation 5.3 below. Copyright © 2006 Pearson Addison-Wesley. All rights reserved.

Risk Measurement for a Single Asset: Standard Deviation (cont.) Copyright © 2006 Pearson Addison-Wesley. All rights reserved.

Portfolio Risk and Return An investment portfolio is any collection or combination of financial assets. If we assume all investors are rational and therefore risk averse, that investor will ALWAYS choose to invest in portfolios rather than in single assets. Investors will hold portfolios because he or she will diversify away a portion of the risk that is inherent in “putting all your eggs in one basket.” If an investor holds a single asset, he or she will fully suffer the consequences of poor performance. This is not the case for an investor who owns a diversified portfolio of assets. Copyright © 2006 Pearson Addison-Wesley. All rights reserved.

Portfolio Return The return of a portfolio is a weighted average of the returns on the individual assets from which it is formed and can be calculated as shown in Equation 5.5. Copyright © 2006 Pearson Addison-Wesley. All rights reserved.

Risk of a portfolio Types of Risk- Diversifiable risk (Unsystematic risk) Nondiversifiable Risk(Systematic risk)

EFFICIENT PORTFOLIO The financial manager’s goal is to create an efficient portfolio. A portfolio that maximizes return for a given level of risk or minimizes risk for a given level of return. Therefore we need a way to measure the return and the standard deviation of a portfolio of assets. Copyright © 2006 Pearson Addison-Wesley. All rights reserved.

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