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Introduction to Risk and Return

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Presentation on theme: "Introduction to Risk and Return"— Presentation transcript:

1 Introduction to Risk and Return
Slides by Matthew Will

2 Histogram of Annual Stock Market Returns (1900-2014)
Measuring Risk Histogram of Annual Stock Market Returns ( )

3 Measuring Risk Variance Average value of squared deviations from mean
A measure of volatility Standard Deviation

4 Measuring Risk Coin Toss Game-calculating variance and standard deviation

5 Measuring Risk 19

6 Portfolio Risk The variance of a two stock portfolio is the sum of these four boxes 19

7 Portfolio Risk Example
Suppose you invest 60% of your portfolio in JNJ and 40% in Ford. The expected dollar return on your JNJ is 8.0% and on Ford is 18.8%. The expected return on your portfolio is: 19

8 Portfolio Risk Example
Suppose you invest 60% of your portfolio in JNJ and 40% in Ford. The expected dollar return on your JNJ is 8.0% and on Ford is 18.8%. The standard deviation of their annualized daily returns are 13.2% and 31.0%, respectively. Assume a correlation coefficient of 1.0 and calculate the portfolio variance. 19

9 Portfolio Risk Example
Suppose you invest 60% of your portfolio in JNJ and 40% in Ford. The expected dollar return on your JNJ is 8.0% and on Ford is 18.8%. The standard deviation of their annualized daily returns are 13.2% and 31.0%, respectively. Assume a correlation coefficient of 1.0 and calculate the portfolio variance. 19

10 Portfolio Risk Example
Suppose you invest 60% of your portfolio in JNJ and 40% in Ford. The expected dollar return on your JNJ is 8.0% and on Ford is 18.8%. The standard deviation of their annualized daily returns are 13.2% and 31.0%, respectively. Assume a correlation coefficient of .019 and calculate the portfolio variance. 19

11 Portfolio Risk Another Example
Suppose you invest 60% of your portfolio in JNJ and 40% in Ford. The expected dollar return on your JNJ is 8.0% and on Ford is 18.8%. The standard deviation of their annualized daily returns are 13.2% and 31.0%, respectively. Assume a correlation coefficient of and calculate the portfolio variance. 19

12 Portfolio Risk Example Correlation Coefficient = .4
Stocks s % of Portfolio Avg Return ABC Corp % % Big Corp % % Standard deviation = weighted avg = 33.6 Standard deviation = Portfolio = 28.1 Real standard deviation: = (282)(.62) + (422)(.42) + 2(.4)(.6)(28)(42)(.4) = CORRECT Return : r = (15%)(.60) + (21%)(.4) = 17.4%

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