1. 11- 1 McGraw Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved Fundamentals of Corporate Finance Sixth Edition Richard A. Brealey Stewart C. Myers Alan J. Marcus Slides by Matthew Will Chapter 10 McGraw Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved Introduction to Risk, Return, and the Opportunity Cost of Capital

2. 11- 2 Topics Covered  Rates of Return: A Review  A Century of Capital Market History  Measuring Risk  Risk & Diversification  Thinking About Risk

3. 11- 3 Rates of Return

4. 11- 4 Rates of Return

5. 11- 5 Rates of Return

6. 11- 6 Rates of Return Nominal vs. Real

7. 11- 7 Market Indexes Dow Jones Industrial Average (The Dow) Value of a portfolio holding one share in each of 30 large industrial firms. Standard & Poor’s Composite Index (The S&P 500) Value of a portfolio holding shares in 500 firms. Holdings are proportional to the number of shares in the issues.

8. 11- 8 The Value of an Investment of $1 in 1900 Source: Ibbotson Associates Index Year Start $22,745 $192 $69 2008

9. 11- 9 Rates of Return Common Stocks (1900-2007) 2007

10. 11- 10 Expected Return

11. 11- 11 Country Risk Premia (%)

12. 11- 12 Measuring Risk Variance - Average value of squared deviations from mean. A measure of volatility. Standard Deviation - Average value of squared deviations from mean. A measure of volatility.

13. 11- 13 Measuring Risk Coin Toss Game-calculating variance and standard deviation

14. 11- 14 Histogram of Returns Return, percent Number of Years

15. 11- 15 Risk and Diversification Diversification - Strategy designed to reduce risk by spreading the portfolio across many investments. Unique Risk - Risk factors affecting only that firm. Also called “diversifiable risk.” Market Risk - Economy-wide sources of risk that affect the overall stock market. Also called “systematic risk.”

16. 11- 16 Risk and Diversification

17. 11- 17 Risk and Diversification

18. 11- 18 Stock Market Volatility 1900-2007 Std Dev 2007

19. 11- 19 The Value of Investments Value (August 2004 = 100)

20. 11- 20 Risk and Diversification

21. 11- 21 Risk and Diversification

22. 11- 22 Thinking About Risk  Message 1  Some Risks Look Big and Dangerous but Really Are Diversifiable  Message 2  Market Risks Are Macro Risks  Message 3  Risk Can Be Measured

23. 11- 23 Web Resources