11- 1 McGraw Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved Fundamentals of Corporate Finance Sixth Edition Richard.

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11- 1 McGraw Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved Fundamentals of Corporate Finance Sixth Edition Richard A. Brealey Stewart C. Myers Alan J. Marcus Slides by Matthew Will Chapter 10 McGraw Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved Introduction to Risk, Return, and the Opportunity Cost of Capital

11- 2 Topics Covered  Rates of Return: A Review  A Century of Capital Market History  Measuring Risk  Risk & Diversification  Thinking About Risk

11- 3 Rates of Return

11- 4 Rates of Return

11- 5 Rates of Return

11- 6 Rates of Return Nominal vs. Real

11- 7 Market Indexes Dow Jones Industrial Average (The Dow) Value of a portfolio holding one share in each of 30 large industrial firms. Standard & Poor’s Composite Index (The S&P 500) Value of a portfolio holding shares in 500 firms. Holdings are proportional to the number of shares in the issues.

11- 8 The Value of an Investment of $1 in 1900 Source: Ibbotson Associates Index Year Start $22,745 $192 $

11- 9 Rates of Return Common Stocks ( ) 2007

Expected Return

Country Risk Premia (%)

Measuring Risk Variance - Average value of squared deviations from mean. A measure of volatility. Standard Deviation - Average value of squared deviations from mean. A measure of volatility.

Measuring Risk Coin Toss Game-calculating variance and standard deviation

Histogram of Returns Return, percent Number of Years

Risk and Diversification Diversification - Strategy designed to reduce risk by spreading the portfolio across many investments. Unique Risk - Risk factors affecting only that firm. Also called “diversifiable risk.” Market Risk - Economy-wide sources of risk that affect the overall stock market. Also called “systematic risk.”

Risk and Diversification

Risk and Diversification

Stock Market Volatility Std Dev 2007

The Value of Investments Value (August 2004 = 100)

Risk and Diversification

Risk and Diversification

Thinking About Risk  Message 1  Some Risks Look Big and Dangerous but Really Are Diversifiable  Message 2  Market Risks Are Macro Risks  Message 3  Risk Can Be Measured

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