1. CHAPTER 6 RISK The Concept of Variability E(R) = Sum of (oi x pi ),
The expected rate of return = E(R).
E(R) = Sum of (oi x pi ),
where oi is the value of the ith observation and pi is it’s probability.
McGraw-Hill/Irwin

2. RISK PREFERENCES Risk-Averse Behavior Risk-Neutral Behavior
Risk-Loving Behavior
McGraw-Hill/Irwin

3. MEASURING PROJECT- SPECIFIC RISK
McGraw-Hill/Irwin

4. Risk Estimates
McGraw-Hill/Irwin

5. RISK MANAGEMENT
Three primary tools may be employed by investors to minimize their expose to risk:
avoid risky projects
use insurance and hedging
diversification
McGraw-Hill/Irwin

6. PORTFOLIO RISK
Diversifiable Risk: (unsystematic risk) can be eliminated by holding assets that are less than perfectly correlated.
Nondiversifiable Risk: (systematic, or market risk) is the risk remaining in a fully-diversified portfolio.
McGraw-Hill/Irwin

7. Diversification and Risk
McGraw-Hill/Irwin

8. Covariance and Correlation
McGraw-Hill/Irwin

9. OPTIMAL PORTFOLIO DECISIONS
Investors base their investment decisions on its contribution to the portfolio’s risk and return.
Efficient investments increase the portfolio’s expected return without adding risk.
Efficient investments decrease the portfolio’s risk for a given expected return.
McGraw-Hill/Irwin

10. Expected Risk and Returns of a Portfolio
McGraw-Hill/Irwin

11. OPTIMAL PORTFOLIO ALLOCATIONS
McGraw-Hill/Irwin

12. HISTORICAL RETURNS & RISK
McGraw-Hill/Irwin

13. HISTORICAL CORRELATIONS (1979-99)
McGraw-Hill/Irwin

14. ACCOUNTING FOR RISK The investor’s required rate of return is (E(Rj)).
E(Rj) = Rf + RPj
where Rf is the risk free rate and RPj is a premium for bearing risk.
McGraw-Hill/Irwin

15. ACCOUNTING FOR RISK Asset Pricing Model to Estimate Risk
Sensitivity Analysis
McGraw-Hill/Irwin