©2012 McGraw-Hill Ryerson Limited 1 of 31 Learning Objectives 1.Describe the concept of risk based on the uncertainty of future cash flows. (LO1) 2.Characterize.

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©2012 McGraw-Hill Ryerson Limited 1 of 31 Learning Objectives 1.Describe the concept of risk based on the uncertainty of future cash flows. (LO1) 2.Characterize most investors as risk averse. (LO2) 3.Analyze risk as standard deviation, coefficient of variation or beta. (LO3) 4.Integrate the basic methodology of risk- adjusted discount rates for dealing with risk in capital budgeting analysis. (LO4)

©2012 McGraw-Hill Ryerson Limited 2 of 31 Statistical Measurements of Risk Expected Value:D –weighted average of possible outcomes (forecasts) times their probabilities –the most likely forecast (best estimate) Standard Deviation: σ –measure of dispersion or variability around the expected value –measure of the spread of possible outcomes –larger the standard deviation  greater the risk Coefficient of Variation: V –standard deviation / expected value –allows comparison of investments of different sizes –larger the coefficient of variation  greater the risk LO3

©2012 McGraw-Hill Ryerson Limited 3 of 31 Figure 13-3 Probability distribution with differing degrees of risk LO3

©2012 McGraw-Hill Ryerson Limited 4 of 31 Which Investment is the Riskiest? With the same expected value, the standard deviation is a good measure of risk. Investments with quite different expected values, require the coefficient of variation to better measure risk. LO3

©2012 McGraw-Hill Ryerson Limited 5 of 31 Statistical measure of volatility (risk) (covariance/market covariance)  measures how responsive or sensitive a company’s stock is to market movements in general An individual stock’s beta shows how risky it compares to the market as a whole: –beta = 1 means equal risk with the market –beta > 1 means more risky than the market –beta < 1 means less risky than the market Company risk may provide guideline to risk of a new investment in that company LO3 Risk in a Portfolio

©2012 McGraw-Hill Ryerson Limited 6 of 31 Table 13-2 Betas, July 2011 LO3 Source: Company NameBeta Bombardier (BBD.bTO)……………………………………………………… … Canadian Tire (CTC.TO)………………………………………………………… 0.63 Power Corp. (POW.TO………………………………………………………… Potash Corp. (POT.TO)………………………………………………………… RIM (RIM.TO)………………………………………………………… ………… Royal Bank (RY.TO)…………………………………………………………

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