Chapter 6 The Returns and Risks from Investing. Function of both return and risk – At the centre of security analysis How should realized return and risk.

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Presentation transcript:

Chapter 6 The Returns and Risks from Investing

Function of both return and risk – At the centre of security analysis How should realized return and risk be measured? – The realized risk-return tradeoff is based on the past – The expected future risk-return tradeoff is uncertain and may not occur Asset Valuation

Returns consist of two elements: – Yield: Periodic cash flows such as interest or dividends (income return) “Yield” measures relate income return to a price for the security – Capital Gain or Loss: Price appreciation or depreciation The change in price of the asset Total Return = Yield + Price Change Return Components

Two general types: – Systematic (market) risk economy wide factors that impact returns – Non-systematic (non-market) risk Unique characteristics specific to a security Total Risk measured by volatility Systematic risk measured by beta Risk Types

Measures Describing a Return Series Arithmetic mean, or simply mean Geometric mean defined as the n-th root of the product of n return relatives minus

Risk is the chance that the actual outcome will be different than the expected outcome Standard Deviation measures the deviation of returns from the mean Measuring Risk

Premium is additional return earned or expected for additional risk Equity risk premium is the difference between stock and risk-free returns Bond default premium is the difference between the return on long term corporate bonds and long term government bonds Risk Premiums

SeriesGeom Mean Arithm Mean Standard Deviation Canadian Common Stocks 10.32%11.53%16.36% US Common Stocks 12.09%13.5%17.67% Long-term Government of Canada Bonds 6.07%6.46%9.39% T-bills 5.20%5.28%4.36% Inflation (CPI) 3.97%4.05%3.63% Annual Total Returns ( )