Contemporary Investments: Chapter 2 Chapter 2 FUNDAMENTALS OF RISK AND RETURN What are the sources of investment returns? How are investment returns measured? What is investment risk and how is it measured? How are risk and return measured for portfolios of assets? Why does diversification benefit investors? What is the relationship between risk and required return?

Contemporary Investments: Chapter 2 Sources of investment returns Income Interest Dividends Price changes: Capital gains or Capital losses Paper gains and losses Ex-ante and ex-post returns

Contemporary Investments: Chapter 2 Measuring investment returns Calculating holding period returns Breaking down returns between income and capital gains Calculating expected returns Inflation adjusted returns International returns Total return indexes

Contemporary Investments: Chapter 2 Investment History –The Agony of Bond Investors:

Contemporary Investments: Chapter 2 Figure 2.1 – Total Return Index for Johnson & Johnson:

Contemporary Investments: Chapter 2 Summarizing returns Arithmetic mean Annualizing the arithmetic mean Geometric mean Comparing the geometric and arithmetic means

Contemporary Investments: Chapter 2 Investment risk A definition of risk: uncertainty of return Types (sources) of risk Default, Credit, Tax, Interest Rate, Market, Event, Liquidity, Foreign Exchange Measuring risk Calculating a standard deviation Annualizing a standard deviation

Contemporary Investments: Chapter 2 Figure 2.2 – Probability of Possible Return

Contemporary Investments: Chapter 2 Figure 2.3 – Stock and T-Bill Returns:

Contemporary Investments: Chapter 2 Figure 2.4 – Monthly Returns for 3M and Starbucks

Contemporary Investments: Chapter 2 Risk, return and investment selection Portfolio risk and return Finding the mean return of a portfolio Finding the standard deviation of a portfolio Correlation coefficient

Contemporary Investments: Chapter 2 Figure 2.5 – Monthly Returns for Dow Chemical and Verizon Communication

Contemporary Investments: Chapter 2 Diversification Naïve versus efficient diversification Diversifiable versus non-diversifiable risk Diversifiable or unsystematic risk Non-diversifiable or systematic risk Beta Risk and required return

Contemporary Investments: Chapter 2 Figure 2.6 – Real and Nominal Returns on T-Bills:

Contemporary Investments: Chapter 2 Figure 2.7 – Yields on T-Bills, T-Bonds, and Baa Corporate Bonds: