BUA321 Chapter 8 Class notes. Risk and Return If you are thinking of investing in a stock, what things would you investigate? What is inside trading?

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Presentation transcript:

BUA321 Chapter 8 Class notes

Risk and Return If you are thinking of investing in a stock, what things would you investigate? What is inside trading? What does this mean: “There is no such thing as a free lunch”?

Stock Fraud Bernie Madoff _detailpage&v=s68FR1MXT8Q

HPR Calculate the holding period return for TAP. Dividends totaled $3.90.

Returns What does history tell us about stock returns? How would you describe Risk?

Return distribution If you purchased a stock for $27 last year and this year it is worth $45. What was the return? Calculate the statistics for this asset. $45 Change % Predicted price Predicted Return Probability Next yearGood economy Average Economy Bad Economy

Return distribution If you purchased a stock for $37 last year and this year it is worth $45. What was the return? Calculate the statistics for this asset. $45 Change % Predicted price Probability Next yearGood economy 15% Average Economy 7% Bad Economy -2%

Risk Example Combine your prices with 2 other people. Create 3 portfolios. Complete the following table. AssetExpected returnStandard DeviationCV Port1 Port2 Port3

Efficient Frontier Combine 2 assets into a portfolio. Insert the picture of the efficient frontier of the portfolio.

What can you say about the information in the following table:

Terminology What is meant by “Do Not Put All Your Eggs in One Basket”

Calculate the return on the following portfolio: Asset$ investedReturn A5,0009% B7,00012% C1,0006% D10,00019% E1,5004% F2,0007% G7,00010%

Portfolio What does correlation describe? What does CAPM describe? What things create diversifiable risk? Non-diversifiable risk? What is beta?

Portfolio Beta Asset$ investedReturn Beta A5,0009%1.25 B7,00012%1.75 C1,0006%.54 D10,00019%2.79 E1,5004%.32 F2,0007%.75 G7,00010%1.95

CAPM and SML Use the beta of the above portfolio to calculate the expected return of a portfolio. Use the 30 year Treasury yield for the risk free rate and 12% for the average return of the market.

Group activity Complete the following exercise – Find the expected returns for your individual asset using this spreadsheet Use the same market and RF returns – You are given $100,000 to invest in your groups stocks – Find the betas for you company and input into the portfolio beta and return worksheet – Decide how much to invest in each asset – Calculate the expected returns for this portfolio

Numbers investors should know.

BUA321 Chapter 08 Web 80 points 1) calculate the statistics for the following investments: eventPrr x r y r z very good good Avg Bad Very Bad Asset XAsset YAsset Z E( R) Variance Standard deviation CV

2) For the above assets, create the portfolios below a) 40% X, 35% Y, 25% Z b) 60% X, 40% Y c)35% Y, 65% Z Portfolio aPortfolio bPortfolio c E( R) Variance Standard deviation CV

3) Calculate the portfolio statistics for the following assets: weightreturnvariance beta XYZ DEF HIJ correlation XYZDEFHIJ XYZ DEF HIJ1.0 Portfolio A (.35,.25,.40) Portfolio B(.45,.25,.30) Portfolio C (.10,.75,.15)

Portfolio A (.35,.25,.40) Portfolio B (.45,.25,.30) Portfolio C (.10,.75,.15) E( R) Variance Standard deviation Beta CV

SML 4) If the risk free rate of return is 3.75% and the stock market averages 12%, What is the expected return on the portfolios using the SML? A B C

5) Go to Yahoo Finance find your company. Go to historical prices and download the past 5 years of prices and dividends. (Hint select monthly prices, download, then select dividends only) a) delete all prices except the first month and the last month. b) add all the dividends. c) calculate the holding period return for your stock d) combine this return with the returns of two other classmates and insert in the table below. Stock TickerReturn

e) Determine the growth and probabilities you expect in the upcoming economic conditions. Economic conditionGrowthProbability Very Good Good Average Bad Very Bad

f) Determine the expected returns one year from today using the above information Economic condition Stock 1Stock 2Stock 3 Very Good Good Average Bad Very Bad

g) create a portfolio using stocks and calculate the returns: 1) 1 & 2 2) 2 & 3 3) 1 & 3 PortfolioReturnsStand DeviationCV 1 2 3

h) copy and paste the efficient frontiers from the worksheet

SML What are the betas of the company stocks? Create a portfolio using the three stocks and calculate the portfolio beta. AssetsBetasWeights

j) Use the beta above and the 30 year risk free rate and stock market average return of 12% the determine the expected return of the portfolio return.