Risk and Return Risk and return defined –Average return –Total (absolute) risk –Total (relative) risk Portfolio risk and diversification effect Systematic.

Slides:

Advertisements

Similar presentations

Chapter 8 Risk and Return. Topics Covered  Markowitz Portfolio Theory  Risk and Return Relationship  Testing the CAPM  CAPM Alternatives.

Advertisements

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

Chapter Outline Expected Returns and Variances of a portfolio

Risk and Rates of Return

Chapter 8 Risk and Return—Capital Market Theory

11-1 Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

Today Risk and Return Reading Portfolio Theory

Return, Risk, and the Security Market Line

Chapter 5 Risk and Rates of Return © 2005 Thomson/South-Western.

Defining and Measuring Risk

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

© 2003 The McGraw-Hill Companies, Inc. All rights reserved. Return, Risk, and the Security Market Line Lecture 11.

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides.

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.

5-1 CHAPTER 8 Risk and Rates of Return Outline Stand-alone return and risk Return Expected return Stand-alone risk Portfolio return and risk Portfolio.

McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

11-1 Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

Presented by: Lauren Rudd

Return, Risk, and the Security Market Line

Measuring Returns Converting Dollar Returns to Percentage Returns

Risk, Return, and Security Market Line

1 Chapter 2: Risk & Return Topics Basic risk & return concepts Stand-alone risk Portfolio (market) risk Relationship between risk and return.

Expected Return for Individual Stocks

Ch 6.Risk, Return and the CAPM. Goals: To understand return and risk To understand portfolio To understand diversifiable risks and market (systematic)

6 Analysis of Risk and Return ©2006 Thomson/South-Western.

1 Overview of Risk and Return Timothy R. Mayes, Ph.D. FIN 3300: Chapter 8.

Risks and Rates of Return

Requests for permission to make copies of any part of the work should be mailed to: Thomson/South-Western 5191 Natorp Blvd. Mason, OH Chapter 11.

Chapter 4 Risk and Rates of Return © 2005 Thomson/South-Western.

Percentage of sales approach: COMPUTERFIELD CORPORATION Financial Statements Income statementBalance sheet Sales$12,000C AC A $5000Debt$8250 Costs9,800FA.

Chapter 11 Risk and Return. Expected Returns Expected returns are based on the probabilities of possible outcomes In this context, “expected” means average.

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

11-1 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan.

Review Risk and Return. r = expected rate of return. ^

Risk and Return. Expected return How do you calculate this? – States of the economy table What does it mean?

Chapter 06 Risk and Return. Value = FCF 1 FCF 2 FCF ∞ (1 + WACC) 1 (1 + WACC) ∞ (1 + WACC) 2 Free cash flow (FCF) Market interest rates Firm’s business.

CAPM Capital Asset Pricing Model By Martin Swoboda and Sharon Lu.

1 Risk Learning Module. 2 Measures of Risk Risk reflects the chance that the actual return on an investment may be different than the expected return.

8-1 CHAPTER 8 Risk and Rates of Return Stand-alone risk Portfolio risk Risk & return: CAPM / SML.

The Basics of Risk and Return Corporate Finance Dr. A. DeMaskey.

Essentials of Managerial Finance by S. Besley & E. Brigham Slide 1 of 27 Chapter 4 Risk and Rates of Return.

1 Risk and Rates of Return What does it mean to take risk when investing? How are risk and return of an investment measured? For what type of risk is an.

Introductory Investment Analysis Part II Course Leader: Lauren Rudd January 12, weeks.

1 Estimating Return and Risk Chapter 7 Jones, Investments: Analysis and Management.

Ch 13. Return, Risk and Security Market Line (SML)

Chapter 6 Risk and Rates of Return 2 Chapter 6 Objectives Inflation and rates of return How to measure risk (variance, standard deviation, beta) How.

Chapter 11 Risk and Rates of Return. Defining and Measuring Risk Risk is the chance that an unexpected outcome will occur A probability distribution is.

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

U6-1 UNIT 6 Risk and Return and Stock Valuation Risk return tradeoff Diversifiable risk vs. market risk Risk and return: CAPM/SML Stock valuation: constant,

12-1. Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 12 Return, Risk, and the Security Market Line.

Measuring the Ex Ante Beta

13-0 Return, Risk, and the Security Market Line Chapter 13 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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

1 CHAPTER 2 Risk and Return. 2 Topics in Chapter 2 Basic return measurement Types of Risk addressed in Ch 2: Stand-alone (total) risk Portfolio (market)

1 Chapter 7 Risk, Return, and the Capital Asset Pricing Model.

2 - 1 Copyright © 2002 by Harcourt College Publishers. All rights reserved. Chapter 2: Risk & Return Learning goals: 1. Meaning of risk 2. Why risk matters.

1 CHAPTER 6 Risk, Return, and the Capital Asset Pricing Model (CAPM)

Key Concepts and Skills

Return and Risk The Capital Asset Pricing Model (CAPM)

FIGURE 12.1 Walgreens and Microsoft Stock Prices,

Risk and Rates of Return

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

Principles of Investing FIN 330

Return, Risk, and the SML RWJ-Chapter 13.

Portfolio Theory and the Capital Asset Pricing Model

McGraw-Hill/Irwin Copyright © 2014 by the McGraw-Hill Companies, Inc. All rights reserved.

Chapter 6 Risk and Rates of Return.

Ch. 11: Risk and Return Expected Returns & Variances

Presentation transcript:

Risk and Return Risk and return defined –Average return –Total (absolute) risk –Total (relative) risk Portfolio risk and diversification effect Systematic Vs. non-systematic risk Beta and “reward to risk” CAPM

Return The additional cents on the dollar invested… k=(profit+additional cash flows)/initial investment Over a period of time…average return Arithmetic Return: Geometric Return: Why do returns matter? –$ does not mean much…alone –Cross-comparison between markets –Are “normally distributed”

Risk We need to think in terms of estimates in an uncertain world: Estimate=average return +/- some volatility Uncertainty or volatility of returns Standard deviation of returns Measured in % What does it mean?

Risk and Return How to compare assets? Which one do you pick? What is the problem here?

Think… Goal: FUN Choice 1: Orlando (3 theme parks) Choice 2: Hampshire (biggest inflatable bouncy castle) You equal utility for any of these attractions... Trick: There is one chance on two that each attraction will be closed There is one chance on two that Indianapolis Airport will be closed 1.Which one do you pick? 2.Think about the risks of not having fun, which one really matters?

Portfolio effect Portfolio Return is the weighted average return of each asset in the portfolio Portfolio Risk is not the weighted average risk of each asset in the portfolio. Portfolio risk has to do with each asset’s weight and risk, but also the degree to which they move together (ρ)

Mathematical Explanation

Portfolio risk and return…in English Portfolio return= (weighted) average assets’ return Portfolio risk = (weighted) average assets’ risk -(weighted) average assets prices’ propensity to move in opposite direction Or Portfolio risk = (weighted) average assets’ risk - Benefits from diversification

Risk and Diversification Announcements and news contain both an expected component and a surprise component; it is the surprise component that affects a stock’s price and therefore its return. Return=expected+unexpected Risk (return)= 0 + market risk + business risk The trick: if you hold many securities, the particularities of each security becomes irrelevant…thus, in a well diversified portfolio business- specific risk is irrelevant!

Risk that matters… If only market risk matters, then the risk premium of a security should be related (somehow) to the market risk premium! Let’s assume that those risk premiums are proportional: security risk premium=β x market risk premium This β is a multiplier which has to do with the relative risk premium of a security to the market risk premium…it is a relative Market (systematic) Risk

CAPM k i =k RF + k RP, then… –Security risk premium = (k i - k RF ) –Market risk premium = (k m - k RF ) If security risk premium=β x market risk premium Then, (k i - k RF) =β x (k m - k RF ) That is, k i = k RF +β x (k m - k RF ) This is also known as the SML (market equilibrium), a component of the CAPM As a result, any security’s return can calculated using β, k RF, and k m

Some Questions What if the observed returns are different from the theoretical returns? What is the market “relative” risk (β)? What does a β of 2 mean? What does a β of.5 mean? What does a β of –1 mean? How do we measure β? What is the β of a portfolio? Impact of inflation and risk aversion on expected returns