Investment. An Investor’s Perspective An investor has two choices in investment. Risk free asset and risky asset For simplicity, the return on risk free.

Slides:

Advertisements

Similar presentations

Fi8000 Risk, Return and Portfolio Theory

Advertisements

1 CHAPTER TWELVE ARBITRAGE PRICING THEORY. 2 FACTOR MODELS ARBITRAGE PRICING THEORY (APT) –is an equilibrium factor mode of security returns –Principle.

Chapter 11 Optimal Portfolio Choice

P.V. VISWANATH FOR A FIRST COURSE IN INVESTMENTS.

The Capital Asset Pricing Model. Review Review of portfolio diversification Capital Asset Pricing Model  Capital Market Line (CML)  Security Market.

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Return and Risk: The Capital Asset Pricing Model (CAPM) Chapter.

FIN352 Vicentiu Covrig 1 Asset Pricing Models (chapter 9)

Asset Allocation Week 4. Asset Allocation: The Fundamental Question How do you allocate your assets amongst different assets ? –There are literally thousands.

The Cost of Capital and Leveraged  s R i = R f +  i, l *[R m - R f ]

© 2003 The McGraw-Hill Companies, Inc. All rights reserved. Return, Risk, and the Security Market Line Chapter Thirteen.

AN INTRODUCTION TO PORTFOLIO MANAGEMENT

Efficient Frontier Capital Market Line Security Market Line

Portfolio Analysis and Theory

Models of Risk 2003,3,24. What is risk? Risk: to expose to hazard or danger Risk = riscare (dare to do something) Risk = 危機 (danger and opportunity)

Risk and Return - Part 2 Efficient Frontier Capital Market Line Security Market Line.

FIN352 Vicentiu Covrig 1 Risk and Return (chapter 4)

Return and Risk: The Capital Asset Pricing Model Chapter 11 Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

© 2003 The McGraw-Hill Companies, Inc. All rights reserved. Return, Risk, and the Security Market Line Chapter Thirteen.

Investment Analysis and Portfolio Management

AN INTRODUCTION TO PORTFOLIO MANAGEMENT

Financial Management Lecture No. 25 Stock Betas and Risk

Uncertainty, Financing and Limited Liability. Uncertainty The necessity of fixed cost often raises the question of financing. Sometimes financing cannot.

Bonds Are Safe They come with two promises: The income stream they provide is usually fixed and relatively certain. They will not mature at less than.

Measuring Returns Converting Dollar Returns to Percentage Returns

BF 320: Investment & Portfolio Management M.Mukwena.

Portfolio Management Lecture: 26 Course Code: MBF702.

Cost of Capital MF 807 Corporate Finance Professor Thomas Chemmanur.

The Capital Asset Pricing Model (CAPM)

Portfolio Management-Learning Objective

Risk and Return CHAPTER 5. LEARNING OBJECTIVES  Discuss the concepts of portfolio risk and return  Determine the relationship between risk and return.

Investment Analysis and Portfolio Management Chapter 7.

Investment. A Simple Example In a simple asset market, there are only two assets. One is riskfree asset offers interest rate of zero. The other is a risky.

A History of Risk and Return

Risk and Capital Budgeting Chapter 13. Chapter 13 - Outline What is Risk? Risk Related Measurements Coefficient of Correlation The Efficient Frontier.

0 Portfolio Managment Albert Lee Chun Construction of Portfolios: Introduction to Modern Portfolio Theory Lecture 3 16 Sept 2008.

McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 7 Capital Allocation Between The Risky And The Risk-Free.

Mean-variance Criterion 1 IInefficient portfolios- have lower return and higher risk.

FIN 351: lecture 6 Introduction to Risk and Return Where does the discount rate come from?

Chapter 4 Appendix 1 Models of Asset Pricing. Copyright ©2015 Pearson Education, Inc. All rights reserved.4-1 Benefits of Diversification Diversification.

Risk and Return Professor Thomas Chemmanur Risk Aversion ASSET – A: EXPECTED PAYOFF = 0.5(100) + 0.5(1) = $50.50 ASSET – B:PAYS $50.50 FOR SURE.

 Risk and Return Principles of Corporate Finance Brealey and Myers Sixth Edition Slides by Matthew Will Chapter 8 © The McGraw-Hill Companies, Inc., 2000.

RISK AND RETURN: AN OVERVIEW OF CAPITAL MARKET THEORY CHAPTER 4.

“Differential Information and Performance Measurement Using a Security Market Line” by Philip H. Dybvig and Stephen A. Ross Presented by Jane Zhao.

Risk and Return: Portfolio Theory and Assets Pricing Models

13 0 Return, Risk, and the Security Market Line. 1 Key Concepts and Skills  Know how to calculate expected returns  Understand the impact of diversification.

Return and Risk: The Asset-Pricing Model: CAPM and APT.

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Corporate Finance Ross  Westerfield  Jaffe Seventh Edition.

Capital Market Theory. Outline  Overview of Capital Market Theory  Assumptions of Capital Market Theory  Development of Capital Market Theory  Risk-Return.

1 Lecture 11: U ncertainty Supplementary stuff about uncertainty.

PORTFOLIO THEORY. Risk & Return Return over Holding Period Return over multiple periods Arithmetic Mean Geometric Mean Dollar Averaging or IRR Return.

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Corporate Finance Ross  Westerfield  Jaffe Seventh Edition.

Chapter 14 – Risk from the Shareholders’ Perspective u Focus of the chapter is the mean-variance capital asset pricing model (CAPM) u Goal is to explain.

10-0 McGraw-Hill Ryerson © 2003 McGraw–Hill Ryerson Limited Corporate Finance Ross  Westerfield  Jaffe Sixth Edition 10 Chapter Ten The Capital Asset.

Class Business Debate #2 Upcoming Groupwork – Spreadsheet Spreadsheet.

Aggregate Stock Market 1. Introduction The standard framework for thinking about aggregate stock market behavior has been the consumption-based approach.

AcF 214 Tutorial Week 5. Question 1. a) Average return:

FIN437 Vicentiu Covrig 1 Portfolio management Optimum asset allocation Optimum asset allocation (see chapter 8 RN)

Risk and return Expected returns are based on the probabilities of possible outcomes In this context, “expected” means “average” if the process is repeated.

Return and Risk Lecture 2 Calculation of Covariance

Capital Market Line and Beta

Capital Market Theory: An Overview

Key Concepts and Skills

Return and Risk The Capital Asset Pricing Model (CAPM)

Investment Analysis and Portfolio management

Return and Risk: The Capital Asset Pricing Models: CAPM and APT

Rate of Return and Risk.

Questions-Risk, Return, and CAPM

Asset Pricing Models Chapter 9

Risk and Return Lessons from Market History

Financial Markets – Fall, 2019 – Sept 12, 2019

Presentation transcript:

Investment

An Investor’s Perspective An investor has two choices in investment. Risk free asset and risky asset For simplicity, the return on risk free asset is zero. The return on risky asset is 1+d for probability p, 1-d for probability 1-p Investor want to maximize his long term return. How should he allocate resources between risk free and risky assets?

Solution Suppose the investor will allocate portion x into risky asset and portion 1-x into riskless asset. The expected rate of return for him is

To determine the value of x at which the portfolio will have the maximal rate of return, we differentiate the above formula with respect to x.

The above differentiation equals zero when At this value of x, the portfolio obtains the highest expected geometric return.

Some numerical examples Assume d = 25%, which is roughly equivalent to standard deviation of 25% for a stock. We set p = 0.55, 0.575, 0.60, 0.625

Example Suppose p = 0.575, d = 0.25 for the risky asset and the risk free rate is 0. What are the expected geometric returns if the portion of the risky asset is 30%, 60% and 90%? What are the expected arithmetic returns if the portion of the risky asset is 30%, 60% and 90%?

Answers expected geometric return expected arithmetic return

Geometric and arithmetic returns In practice, arithmetic means are used to measure performance. Geometric means provide more relevant measure for investors Example: First year 100% return, second year -50%. What is the average return from two years?

Higher Risk, Higher Return? True up to a certain level. If p = 0.6, up to the level of 80% of risky asset, higher risk, higher return. Over 80% limit, higher risk, lower return. In the past, high equity return. Putting all assets in equity may provide high return. If equity premium is lower in the future, as in the past ten years in most of the stock markets, return and risk pictures could be different.

A comparison with standard theory In standard theory, there is always a risk return tradeoff. In our theory, there is a highest possible return at a certain point. The standard theory is a two parameter theory. Ours is a one parameter theory.

Utility based or return based? A deeper sense of difference is whether economic theory should be utility based on return based Measurement of company performances is return based Human decisions are utility based. It is often claimed that human beings have free will. However, company managers are human beings and have free will as well.

Both companies and individuals are subject to the requirement of positive returns. If a person makes a bad investment decision, his wealth will shrink and his impact on market will decline.

Difference on investment decisions In CAPM, there is a capital market line. Investors can pick any point on capital market line based on his utility function. In a geometric return based theory, the ones choose higher rates of return will gradually holding higher shares of total wealth than the ones choose lower rates of return.

Capital Market Line